Professional Documents
Culture Documents
Menu
All Courses
o Certification Programs
Compare Certifications
FMVA®Financial Modeling & Valuation Analyst
CBCA™Commercial Banking & Credit Analyst
CMSA®Capital Markets & Securities Analyst
BIDA™Business Intelligence & Data Analyst
FPWM®Financial Planning & Wealth Management Professional
o Specializations
CREF SpecializationCommercial Real Estate Finance
ESG SpecializationEnvironmental, Social & Governance (ESG)
BE BundleBusiness Essentials
o Popular Topics
Browse All Topics
Cryptocurrency3 courses
Excel26 courses
Accounting 3 courses
Commercial Real Estate11 courses
ESG8 courses
Wealth Management8 courses
Foreign Exchange5 courses
Management Skills10 courses
Machine Learning1 courses
Financial Modeling12 courses
FP&A6 courses
Business Intelligence12 courses
o Browse All Courses
Corporate Training
Pricing
o For Individuals
o For Teams
Resources
o Popular Resources
Browse All Topics
Career285 resources
Team Development12 resources
eLearning17 resources
FP&A
Excel587 resources
Accounting738 resources
ESG59 resources
Financial Modeling283 resources
Cryptocurrency56 resources
Wealth Management832 resources
Data Science & Machine Learning180 resources
Management316 resources
o Browse All Resources
My Account
o My Courses
o My Resources
o My Profile
o Account Settings
o Sign Out
My Dashboard
Log In
Get Started
My Dashboard
Get Started
Browse All Courses
My Account
o My Courses
o My Resources
o My Profile
o Account Settings
o Sign Out
Certification Programs
o Financial Modeling & Valuation (FMVA)®
o Certified Banking & Credit Analyst (CBCA)™
o Capital Markets & Securities Analyst (CMSA)®
o Business Intelligence & Data Analyst (BIDA)™
o Financial Planning & Wealth Management Professional (FPWM)®
Specializations
o Commercial Real Estate Finance Specialization
o Environmental, Social & Governance Specialization
o Business Essentials Bundle
Corporate Training
o Overview
o Pricing
Pricing
Resources
Get Started
My Dashboard
Log In
Home › Resources › Valuation › Hurdle Rate Definition
Before accepting and implementing a certain investment project, its internal rate of
return (IRR) should be equal to or greater than the hurdle rate. Any potential
investments must possess a return rate that is higher than the hurdle rate in
order for it to be acceptable in the long run.
Most companies use their weighted average cost of capital (WACC) as a hurdle rate
for investments. This stems from the fact that companies can buy back their own
shares as an alternative to making a new investment, and would presumably
earn their WACC as the rate of return. In this way, investing in their own shares
(earning their WACC) represents the opportunity cost of any alternative
investment.
Another way of looking at the hurdle rate is that it’s the required rate of return
investors demand from a company. Therefore, any project the company invests
in must be equal to or ideally greater than its cost of capital.
A more refined approach is to look at the risk of individual investments and add
or deduct a risk premium based on that. For example, a company has a WACC of
12% and half its assets are in Argentina (high risk), and half its assets are in the
United States (low risk). If the company is looking at one new investment in
Argentina and one new investment in the United States, it should not use the
same hurdle rate to compare them. Instead, it should use a higher rate for the
investment in Argentina and a lower one for the investment in the U.S.
Risk premium – Assigning a risk value for the anticipated risk involved with
the project. Riskier investments generally have greater hurdle rates than less
risky ones.
Inflation rate – If the economy is experiencing mild inflation, that may
influence the final rate by 1%-2%. There are instances when inflation may be
the most significant factor to consider.
Interest rate – Interest rates represent an opportunity cost that could be
earned on another investment, so any hurdle rate needs to be compared to
real interest rates.
How to Use the Hurdle Rate to Evaluate an Investment
The most common way to use the hurdle rate to evaluate an investment is by
performing a discounted cash flow (DCF) analysis. The DCF analysis method uses
the concept of the time value of money (opportunity cost) to forecast all future
cash flows and then discount them back to today’s value to provide the net
present value.
In order to do this, the company needs to perform some financial modeling. The
first step is to model out all the revenues, expenses, capital costs, etc., in an Excel
spreadsheet and develop a forecast. The forecast needs to include the free cash
flow of the investment over its lifetime. Once all the cash flows are in place, use
the XNPV function in Excel to discount the cash flows back to today at the set
hurdle rate. If the resulting Net Present Value (NPV) is greater than zero, the
project exceeds the hurdle rate, and if the NPV is negative it does not meet it.
As you can see in the example above, if a hurdle rate (discount rate) of 12% is
used, the investment opportunity has a net present value of $378,381. This
means if the cost of making the investment is less than $378,381, then its
expected return will exceed the hurdle rate. If the cost is more than $378,381,
then the expected return will be lower than the hurdle rate.
Learn more about rates of return in CFI’s financial modeling & valuation courses.
The hurdle rate is often set to the weighted average cost of capital (WACC), also
known as the benchmark or cut-off rate. Generally, it is utilized to analyze a
potential investment, taking the risks involved and the opportunity cost of
foregoing other projects into consideration. One of the main advantages of a
hurdle rate is its objectivity, which prevents management from accepting a
project based on non-financial factors. Some projects get more attention due to
popularity, while others involve the use of new and exciting technology.
It’s not always as straightforward as picking the investment with the highest
internal rate of return. A few important points to note are:
Hurdle rates can favor investments with high rates of return, even if the
dollar amount (NPV) is very small.
They may reject huge dollar value projects that may generate more cash for
the investors but at a lower rate of return.
The cost of capital is usually the basis of a hurdle rate and it may change over
time.
More Resources
Thank you for reading CFI’s guide on Hurdle Rate. To keep advancing your career,
the additional CFI resources below will be useful:
Company
o About
o Meet Our Team
o Careers at CFI
o Learner Reviews
o For Teams
o Affiliates
o For Universities
Certifications
o Financial Modeling & Valuation Analyst (FMVA)®
o Commercial Banking & Credit Analyst (CBCA)™
o Capital Markets & Securities Analyst (CMSA)®
o Business Intelligence & Data Analyst (BIDA)™
o Financial Planning & Wealth Management Professional (FPWM)®
o CPE Credits
Courses
o Accounting
o Excel
o Finance
o Financial Modeling
o Environment, Social, Governance (ESG)
o Business Intelligence
o Data Science
o Machine Learning
o All Courses
Support
o Financial Aid
o CFI Is a Proud Partner of Pledge 1%
o Help | FAQ
o Contact Us
o Scholarships
Resources
o Career Resources
o Team Development Resources
o eLearning Tips
o Excel Resources
o Financial Modeling Resources
o Accounting Resources
o All Free Resources
Logo
Logo
Logo
Logo
Logo
Logo
Privacy Policy
Terms of Use
Terms of Service
Legal
Resources
Excel Shortcuts PC Mac List of Excel Shortcuts Excel shortcuts[citation...
Financial Modeling Guidelines CFI’s free Financial Modeling Guidelines is a
thorough and complete resource covering model design, model building blocks,
and common tips, tricks, and...
SQL Data Types What are SQL Data Types? The Structured Query Language (SQL)
comprises several different data types that allow it to store different types of
information...
Structured Query Language (SQL) What is Structured Query Language (SQL)?
Structured Query Language (SQL) is a specialized programming language
designed for interacting with a database....
See All ResourcesSee All
Popular Courses