Hurdle rate

A hurdle rate, also known as a minimum acceptable rate of return (MARR), is the lowest rate of return managers or investors expect to receive on an investment or a project. It is a benchmark for evaluating whether potential investments are financially viable and worth pursuing. 

The hurdle rate takes into account the company’s cost of capital, risk tolerance, investment objectives, and market conditions. If the expected return from an investment exceeds the hurdle rate, it is deemed acceptable. Businesses typically set higher hurdle rates for projects with higher risk levels to compensate for the increased uncertainty. 

The hurdle rate also helps evaluate the performance of existing investments and projects. Businesses assess whether investments meet or exceed expectations by comparing actual returns to the hurdle rate. They can identify underperforming investments that may need to be reevaluated or sold off to allocate resources more effectively.

Suppose a hotel chain is considering constructing a new property in a prime location. The company would assess construction costs, operating expenses, projected room rates, and revenue from amenities like restaurants and spas. The hurdle rate would serve as a benchmark to determine whether the potential profits from the new hotel justify the capital investment required.