Hurdle Rate

The hurdle rate is the minimum rate of return that an investment must generate in order to be considered acceptable. It is used to calculate the present value of an investment and is typically the cost of borrowing money.

Formula:

Hurdle rate = Discount rate that results in a present value of 1 equal to the investment amount

Explanation:

• Hurdle rate: The minimum rate of return required for an investment to be acceptable.
• Discount rate: The rate at which money is discounted to its present value.
• Present value: The amount of money that is received today in exchange for a future sum of money.
• Investment amount: The amount of money invested.

Example:

If you invest $10,000 at a rate of 5%, the present value of the investment will be $10,000. If the hurdle rate is 3%, the investment will not be acceptable because the present value is less than the investment amount.

Uses:

• To determine whether an investment is acceptable.
• To calculate the required rate of return for an investment to be considered acceptable.
• To compare different investments.

Note:

• The hurdle rate is a subjective measure.
• The hurdle rate can vary depending on the industry, market conditions, and individual risk tolerance.
• The hurdle rate should be used in conjunction with other investment metrics, such as the internal rate of return (IRR).