One basic principle of investing states that an investment can only add value if it earns more than its hurdle rate
. Following this principle, a company must generate return on equity above its opportunity cost in order to create intrinsic value into its share price.
Raising the Hurdle Rate
. 75% of the retailers surveyed said they were raising the required hurdle rate
for real estate capital remodels and relocates, and a number described how were planning to defer or cancel the projects that did not meet their more stringent internal rates of return guidelines.
Keywords: capital budgeting; empire-building; residual income; hurdle rates
Consistent with prior expectations, we found self-set hurdle rates
to be an effective control mechanism resulting in significantly lower levels of escalation of commitment.
Therefore, the high variation in hurdle rates
within the company and industry sectors found in surveys indicates that hurdle rates
are not directly linked to the cost of capital.
The above methodology fits fairly neatly into the modelling problem concerning evaluation of hurdle rates
for R&D projects.
Rather than use a build-up approach in corporate acquisition analysis, many companies employ corporate 'hurdle rates
' or 'threshold rates of return.' Hurdle rates
- the minimum rates of return needed to justify an investment - are typically established at senior management levels within an organization, and tend to remain fairly static in the near term, although they can change over time to reflect changes in general economic conditions or industry trends.
Yes, the firm can alter its capital budgeting policy by raising internal hurdle rates
. At first blush, an increase in hurdle rates
would seem to do little to conserve on internal funds.
In addition to clearing our hurdle rates
, the bid packages for these properties offered investor safeguards, including a management contract that effectively provided a revenue floor; an allowance for renegotiating union and other existing contracts; and provisions for protection against currency fluctuations and for the repatriation of profits.
companies still use hurdle rates
of 12% or more to justify capital investments, according to a survey of 612 companies conducted by the Institute of Management Accountants (IMA).
When hurdle rates
increase, share prices tend to fall because the value of growth portion enlarges to the point beyond rational expectations.
This result provides a testable prediction regarding the cross-sectional variation in firms' choices of hurdle rates
for approving capital investment projects.