What is Hurdle Rate?
The Short Answer
Hurdle Rate explained simply
The hurdle rate is the minimum rate of return a project or investment must achieve to be considered viable. Think of it as a benchmark. If a project’s expected return doesn’t clear this benchmark, it’s typically not approved. This rate helps businesses make smart investment decisions by ensuring that new projects contribute positively to their financial health.
Real-World Example
The New Equipment Purchase
A manufacturing company is considering buying new equipment that costs $100,000. They expect this equipment to generate an additional $20,000 in profit each year for the next 10 years. The company has set a hurdle rate of 15%.
To decide if this is a good investment, they calculate the project’s Internal Rate of Return (IRR). If the IRR is 18%, it clears the 15% hurdle rate, making it a good investment. If the IRR is only 12%, it falls short, and the company would likely pass on the purchase.
Why this matters
Understanding the hurdle rate is key for business owners. It helps you decide which projects to invest in and which to skip. This ensures your capital is used wisely, leading to better returns and stronger financial growth for your business.
Always set a hurdle rate that reflects your cost of capital and your desired profit margin. This ensures every investment you make is truly worth it.
Always set a hurdle rate that reflects your cost of capital and your desired profit margin. This ensures every investment you make is truly worth it.
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