Hurdle Rate vs. Internal Rate of Return (IRR): What's the Difference?

When a company decides whether a project is worth the costs that will be incurred in undertaking it, it may evaluate it by comparing the internal rate of return (IRR) on the project to the hurdle rate, or the 澳洲幸运5官方开奖结果体彩网:minimu🌳m acceptable rate 𒀰of return (MARR).

Under this approach, if the I🎉RR is equal to or greater than the hurdle rate, the project is likely to be approved. If it is not, the project is rejected.

Hurdle Rate

The 澳洲幸运5官方开奖结果体彩网:hurdle rate, also call🌠ed the minimum acceptable rate of return, is the lowest rate of return that the project must earn in order to offset the costs of the ಌinvestment.

Projects are also evaluated by 澳洲幸运5官方开奖结果体彩网:discounting future cash flows to the present by the hurdle rate in order to calculate the 澳洲幸运5官方开奖结果体彩网:net present value (NPV), which represents the difference between the present value of cash inflows and the pre𝓰sent value of cash outflows.

Generally, the hurdle rate is equal to the company's 澳洲幸运5官方开奖结果体彩网:costs of capital, which is a combination of the 澳洲幸运5官方开奖结果体彩网:cost of equity and the 澳洲幸运5官方开奖结果体彩网:cost of debt. Managers🦹 typically raise the hurdle rate for riskier projects or when the company is comparing multiple investment opportunit🌊ies.

Internal Rate of Return (IRR)

The internal rate of return is the expected ♛annual amount of money, expressed as a percentage, that the investment can be expected to produce for the company over and above the hurdle rate.

The word "internal" means that the figure does not account for potential external risks and factors such as inflation.

IRR is also used by financial professionals to compute the 澳洲幸运5官方开奖结果体彩网:expected returns on stocks or other investments, such as the yield to mat⛦urity on bonds.

While it is relatively straightforward to evaluate projects by comparing the IRR to the hurdle rate, or MARR, this approach has certain limitations as an investing strategy. For example, it looks only at the rate of return, as opposed to the size of the return. A $2 investment returning $20 has a much higher rate o🌞f return than a $2 million investment returning $4 🐬million.

IRR can only be used when looking at projects and investments that have an initial cash outflow followed by one or more inflows. Also, this method does not consider the possibility that vario🔜us projects might have different durations.