A hurdle rate is the minimum rate of return an investment or project must yield in order to be worth considering. The rate takes appropriate risk and returns on the investment into account. In general, riskier projects are characterized by a higher hurdle rate than less risky investments.
Essentially, the hurdle rate is the point where all costs of an investment and the risk are covered.
General decision rule
If the expected return on the investment is above the hurdle rate than the investment can be further considered. If not, the investment opportunity should be discarded. The expected return is computed by discounting future cash flow streams.
Its important to note that the hurdle rate should never be the only measure for determining the value of an investment, as the rate favors investments with relatively high returns and low risks.
For hedge funds
The hurdle rate is the rate, which the manager must, at least, achieve in order to collect incentive fees.
For any further information or question about hurdle rates, do not hesitate to contact us.
WHU Finance Society e.V.