The hurdle rate, also known as the minimum acceptable rate of return (MARR), is the minimum rate of return a company or investor expects to earn on an investment or project. It represents the opportunity cost of capital and is used to evaluate the profitability of potential investments. A project is typically considered acceptable only if its expected rate of return exceeds the hurdle rate.
How is the Hurdle Rate Calculated?
A common method for calculating the hurdle rate is using the Weighted Average Cost of Capital (WACC). WACC represents the average rate of return a company expects to pay to its security holders to finance its assets. It is calculated as the weighted average of the cost of equity and the after-tax cost of debt.
The formula used in this calculator is a simplified version derived from the Capital Asset Pricing Model (CAPM) for the cost of equity, combined with the cost of debt, weighted by the company's capital structure:
Hurdle Rate (WACC) = (We * Cost of Equity) + (Wd * Cost of Debt)
Explanation of Inputs:
Risk-Free Rate: The theoretical rate of return of an investment with zero risk. Typically represented by the yield on long-term government bonds (e.g., U.S. Treasury bonds).
Equity Risk Premium (ERP): The excess return that investing in the stock market provides over a risk-free rate. It's the compensation investors demand for bearing the extra risk of owning stocks.
Beta (β): A measure of a stock's volatility in relation to the overall market. A beta of 1 means the stock's price will move with the market. A beta greater than 1 indicates higher volatility than the market, and less than 1 indicates lower volatility.
Cost of Debt (Post-Tax): The effective interest rate a company pays on its borrowings after accounting for the tax deductibility of interest expenses.
Debt-to-Equity Ratio (D/E): A financial ratio that indicates the proportion of a company's financing that comes from debt versus equity. It's used to determine the weights of debt and equity in the WACC calculation.
Weight of Equity (We) = 0.5 / (1 + 0.5) = 0.5 / 1.5 = 0.3333 or 33.33%
Weight of Debt (Wd) = 1 – 0.3333 = 0.6667 or 66.67%
Step 3: Calculate Hurdle Rate (WACC)
Hurdle Rate = (0.3333 * 12.2%) + (0.6667 * 4%)
Hurdle Rate = 4.066% + 2.667% = 6.733%
In this example, the hurdle rate is approximately 6.73%. Any project or investment expected to yield less than this rate would typically not be pursued.
function calculateHurdleRate() {
var riskFreeRate = parseFloat(document.getElementById("riskFreeRate").value);
var equityRiskPremium = parseFloat(document.getElementById("equityRiskPremium").value);
var beta = parseFloat(document.getElementById("beta").value);
var costOfDebt = parseFloat(document.getElementById("costOfDebt").value);
var debtToEquityRatio = parseFloat(document.getElementById("debtToEquityRatio").value);
var resultDiv = document.getElementById("hurdleRateResult");
resultDiv.innerHTML = ""; // Clear previous results
// Input validation
if (isNaN(riskFreeRate) || isNaN(equityRiskPremium) || isNaN(beta) || isNaN(costOfDebt) || isNaN(debtToEquityRatio)) {
resultDiv.innerHTML = "Please enter valid numbers for all fields.";
return;
}
if (riskFreeRate < 0 || equityRiskPremium < 0 || beta < 0 || costOfDebt < 0 || debtToEquityRatio < 0) {
resultDiv.innerHTML = "Input values cannot be negative.";
return;
}
// Calculations
var costOfEquity = riskFreeRate + (beta * equityRiskPremium);
// Handle potential division by zero if debtToEquityRatio is -1 (though unlikely with validation)
var weightOfEquity;
var weightOfDebt;
if (1 + debtToEquityRatio === 0) {
resultDiv.innerHTML = "Debt-to-Equity ratio results in division by zero. Please check inputs.";
return;
} else {
weightOfEquity = debtToEquityRatio / (1 + debtToEquityRatio);
weightOfDebt = 1 – weightOfEquity;
}
// Ensure weights are non-negative and sum to 1 (within a small tolerance for floating point errors)
if (weightOfEquity < 0) weightOfEquity = 0;
if (weightOfDebt 1e-9) { // Allow for minor floating point inaccuracies
// Adjust if sum isn't exactly 1 due to extreme D/E ratios or floating point issues, though the formulas should inherently balance
if (totalWeight > 0) {
weightOfEquity /= totalWeight;
weightOfDebt /= totalWeight;
} else {
resultDiv.innerHTML = "Invalid capital structure weights calculated. Please check D/E ratio.";
return;
}
}
var hurdleRate = (weightOfEquity * costOfEquity) + (weightOfDebt * costOfDebt);
resultDiv.innerHTML = "