Necessity of risk adjusted hurdle rates for companies, Finance Basics

Discuss the necessity of risk adjusted hurdle rates for companies with diverse lines of business.

  • Every company invests in new projects based on the expectation of earnings profits. Every investor or lender gives money to a company on the expectation of earning their minimum rate of return. Hurdle rate means the minimum rate of return expected by a company from its capital expenditure projects. Only if the rate of return exceeds the hurdle rate, only then the company should accept the project. As the company can pay back the hurdle rate to the investors and lenders and keep some money for future expansion of projects. This is the rate investors and lenders expect the company to pay to them.
  • Every project may have its own risk and return. Risk will depend upon the variability of the returns. Higher the risk, higher the hurdle rate. There may be some projects such as developing a new product which may be highly risky, as whole money spend on research and development would go waste if the product is not introduced in the market. However, for real estate companies the risk is not very high. If the building are made properly, people will buy the apartments. For eg - healthcare industry has a high hurdle rate due to the inherent high risk of developing vaccines and drugs. For eg - real estate companies have low hurdle rate due to low risk.
  • If the company has one consolidated hurdle rate for its diverse line of businesses, then it may not be able to identify projects which are doing well. High returns generated in one industry might offset the low returns generated by another industry. Proper evaluation of the performance of various line of businesses will be difficult.



Posted Date: 9/17/2012 9:32:39 AM | Location : United States

Related Discussions:- Necessity of risk adjusted hurdle rates for companies, Assignment Help, Ask Question on Necessity of risk adjusted hurdle rates for companies, Get Answer, Expert's Help, Necessity of risk adjusted hurdle rates for companies Discussions

Write discussion on Necessity of risk adjusted hurdle rates for companies
Your posts are moderated
Related Questions
What is the one-year Treasury security rate of 1R1? For 1R3=11%, E(2r1)= 4% and E(3r1)=5%

Example of Replacement of Assets Estate Developers purchased a machine five years ago on a cost of £7,500.  The machine had a probable economic life of 15 years at the moment

Management of Account Receivable In order to keep current customers and attract new ones, most firms find it necessary to offer credit. Accounts receivable represents the exte

Liquidity Preference Theory This theory states that short term bonds are extremely favorable than long term bonds for two (2) purposes. 1. Investors usually prefer short te

Suppose the ABC Corporation is currently all-equity financed and would like to increase its value by issuing debt. The firm has annual earnings before interest and taxes of $7,0

Advantages of Investment in Shares 1. Income in form of dividends When you contain shares of a company then you become a part-owner of such company and hence you will be

Example of NPV Method Resolution limited intends to purchase a machine worth Shs.1, 500,000 that will have a residue value Shs.200,000 after 5 years helpful life. The saving

Potential Investors - Measuring Business Performance Potential investors These parties are interested in a company in total both on long and short term basis in particula

Proforma Balance Sheet This refers to the projected balance sheet at the finish of forecasting period.  The items in the proforma balance that vary with sales would be determi

What is Nominal and Real Return While nominal return is the return in nominal rupees, real return is equal to the nominal return adjusted for changes in prices i.e. rate of