The hurdle rate is the minimum required rate of return for an investment or project so that it does not result in losses.
Thus, an internal rate of return (IRR) that is higher than the hurdle rate would mean that the investment would be able to jump over or clear the financial hurdle.
When hurdle rate is applied in budgeting for capital expenditure, management would have a benchmark to factor in when making business decisions.
For example, when considering whether to take on a project with a 12% return, a hurdle rate of 10% would mean that the project can be taken up with no negative financial implications.
It would make no financial sense to take on a project with 8% returns as the company would effectively be doing a project that would be raking in losses for the business.
When there is excess capacity, a company might still accept a project that has a return rate equal to the hurdle rate just to build the brand.
Workers and resources are not wasted, and the revenue or returns would cover the capital expenses that would be spent.
For this reason, the hurdle rate can also be described as the breakeven rate, cost of capital, or even the interest rate.
Using the discounted cash flow methodology to determine the net present value (NPV) of projects, using hurdle rate as the variable helps companies identify whether a project would be a winner or loser.
The hurdle rate is an important figure that key decision makers of a company needs to keep in mind at all times when evaluating the feasibility of new capital projects.
