Hurdle Rate Calculation Example

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Hurdle Rate Calculator

Results

Weighted Average Cost of Capital (WACC):
Required Hurdle Rate:

Understanding the Hurdle Rate Calculation Example

In capital budgeting, the Hurdle Rate is the minimum rate of return on a project or investment required by a manager or investor. It is essentially the baseline that determines whether a potential project is financially viable. If the Internal Rate of Return (IRR) of a project is lower than the hurdle rate, the investment is typically rejected.

How Hurdle Rate is Calculated

To calculate a realistic hurdle rate, most corporations use their Weighted Average Cost of Capital (WACC) as a starting point and then add a risk premium buffer to account for project-specific risks or inflation. The formula used in our calculator is as follows:

WACC = (Cost of Equity × % Equity) + [Cost of Debt × % Debt × (1 – Tax Rate)]
Hurdle Rate = WACC + Risk Premium

Practical Hurdle Rate Example

Consider "TechGlobal Corp," which is evaluating a new software development project. Here is their financial breakdown:

  • Cost of Equity: 12%
  • Equity Weighting: 70%
  • Cost of Debt: 6%
  • Debt Weighting: 30%
  • Tax Rate: 25%
  • Project Risk Premium: 3%

Step 1: Calculate WACC
WACC = (0.12 × 0.70) + [0.06 × 0.30 × (1 – 0.25)]
WACC = 0.084 + [0.018 × 0.75]
WACC = 0.084 + 0.0135 = 0.0975 or 9.75%

Step 2: Add Risk Premium
Hurdle Rate = 9.75% + 3% = 12.75%

In this example, for the project to be approved, its projected return must exceed 12.75%.

Key Factors Influencing the Hurdle Rate

  1. Cost of Capital: Higher interest rates or higher expectations from shareholders increase the WACC, thereby increasing the hurdle rate.
  2. Risk Profile: A project in a volatile market or a new venture with high uncertainty will require a higher risk premium buffer.
  3. Capital Structure: The mix of debt and equity significantly impacts the cost of capital. Debt is usually cheaper than equity due to tax deductibility.
  4. Inflation: If high inflation is expected, firms will raise their hurdle rate to ensure the "real" return remains positive.
function calculateHurdleRate() { // Get values from inputs var costEquity = parseFloat(document.getElementById('costEquity').value); var equityWeight = parseFloat(document.getElementById('equityWeight').value); var costDebt = parseFloat(document.getElementById('costDebt').value); var debtWeight = parseFloat(document.getElementById('debtWeight').value); var taxRate = parseFloat(document.getElementById('taxRate').value); var riskPremium = parseFloat(document.getElementById('riskPremium').value); // Basic Validation if (isNaN(costEquity) || isNaN(equityWeight) || isNaN(costDebt) || isNaN(debtWeight) || isNaN(taxRate) || isNaN(riskPremium)) { alert('Please enter valid numeric values in all fields.'); return; } // Convert percentages to decimals for calculation var ce = costEquity / 100; var ew = equityWeight / 100; var cd = costDebt / 100; var dw = debtWeight / 100; var tr = taxRate / 100; var rp = riskPremium / 100; // Calculate WACC components var equityComponent = ce * ew; var debtComponent = cd * dw * (1 – tr); var wacc = (equityComponent + debtComponent); // Final Hurdle Rate calculation var hurdleRate = wacc + rp; // Display Results document.getElementById('waccOutput').innerHTML = (wacc * 100).toFixed(2) + '%'; document.getElementById('hurdleRateOutput').innerHTML = (hurdleRate * 100).toFixed(2) + '%'; // Show the result container document.getElementById('hr-result-box').style.display = 'block'; }

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