Calculating a Project's Hurdle Rate

Abstract

Of vital importance to the long‐term profitability and level of investment in a company or indeed an economy is the determination of reliable hurdle rates, or minimum required rates of returns, for investment projects. Hurdle rates set too high lead to missed opportunities for profit and growth. Understating hurdle rate levels give rise to uneconomic investment decisions and fall in market values. As every financial manager faced with the problem of determining these rates of return is aware there are many different approaches, each of which, if followed mechanically, could produce very different solutions. The main reasons for such variances rest in the assumptions underlying the various approaches. This article concentrates on the application of one of the more recent approaches based on the capital asset pricing model (CAPM). Its positive orientation and intuitively appealing conclusions have made it the central equilibrium model of financial economics.