In business and for engineering economics in both industrial engineering and civil engineering practice, the minimum acceptable rate of return, often abbreviated MARR, or hurdle rate is the minimum rate of return on a project a manager or company is willing to accept before starting a project, given its risk and the opportunity cost of forgoing other projects.[1] A synonym seen in many contexts is minimum attractive rate of return.
The hurdle rate is frequently used as a synonym of cutoff rate, benchmark and cost of capital. It is used to conduct preliminary analysis of proposed projects and generally increases with increased risk.
The hurdle rate is usually determined by evaluating existing opportunities in operations expansion, rate of return for investments, and other factors deemed relevant by management. As an example, suppose a manager knows that investing in a conservative project, such as a bond investment or another project with no risk, yields a known rate of return. When analyzing a new project, the manager may use the conservative project's rate of return as the MARR. The manager will only implement the new project if its anticipated return exceeds the MARR by at least the risk premium of the new project.
A risk premium can also be attached to the hurdle rate if management feels that specific opportunities inherently contain more risk than others that could be pursued with the same resources. A common method for evaluating a hurdle rate is to apply the discounted cash flow method to the project, which is used in net present value models. The hurdle rate determines how rapidly the value of the dollar decreases out in time, which, parenthetically, is a significant factor in determining the payback period for the capital project when discounting forecast savings and spending back to present-day terms. Most companies use a 12% hurdle rate, which is based on the fact that the S&P 500 typically yields returns somewhere between 8% and 11% (annualized). Companies operating in industries with more volatile markets might use a slightly higher rate in order to offset risk and attract investors.
The hurdle rate is frequently used as a synonym of cutoff rate, benchmark and cost of capital. Different organizations might have slightly different interpretations, so when multiple organizations (e.g., a startup company and a venture capital firm) are discussing the suitability of investing in a project, it is important that both sides' understanding of the term are compatible for this purpose.[2] The hurdle rate is always higher (usually significantly) than the cost of capital - since generally no project is undertaken by a for profit entity that does not have an expected rate of return higher than the cost of capital (i.e., a profit) and every project has risk ( which must be compensated for).
Project analysisedit
When a project has been proposed, it must first go through a preliminary analysis in order to determine whether or not it has a positive net present value using the MARR as the discount rate.[1] The MARR is the target rate for evaluation of the project investment. This is accomplished by creating a cash flow diagram for the project, and moving all of the transactions on that diagram to the same point, using the MARR as the interest rate. If the resulting value at that point is zero or higher, then the project will move on to the next stage of analysis. Otherwise, it is discarded. The MARR generally increases with increased risk.
Typical valuesedit
The MARR is often decomposed into the sum of the following components (range of typical values shown):[3]
Traditional inflation-free rate of interest for risk-free loans: 3-5%
Expected rate of inflation: 5%
The anticipated change in the rate of inflation, if any, over the life of the investment: Usually taken at 0%
The risk of defaulting on a loan: 0-5%
The risk profile of a particular venture: 0-5% and higher
Notesedit
^ abPark, Chan S. (2007). Contemporary Engineering Economics (4th ed.). Prentice Hall. p. 216. ISBN978-0-13-187628-6.
^Ross, Stephen A., Westerfield, Randolph W., Jaffe, Jeffrey, Corporate Finance, Seventh Edition, McGraw Hill International Edition, 2005, Page 330.
^Lang, Hans J.; Merino, Donald N. (1993). The selection process for capital projects. New York: J. Wiley & Sons. ISBN978-0-471-63425-6.
minimum, acceptable, rate, return, business, engineering, economics, both, industrial, engineering, civil, engineering, practice, minimum, acceptable, rate, return, often, abbreviated, marr, hurdle, rate, minimum, rate, return, project, manager, company, willi. In business and for engineering economics in both industrial engineering and civil engineering practice the minimum acceptable rate of return often abbreviated MARR or hurdle rate is the minimum rate of return on a project a manager or company is willing to accept before starting a project given its risk and the opportunity cost of forgoing other projects 1 A synonym seen in many contexts is minimum attractive rate of return The hurdle rate is frequently used as a synonym of cutoff rate benchmark and cost of capital It is used to conduct preliminary analysis of proposed projects and generally increases with increased risk Contents 1 Hurdle rate determination 2 Project analysis 3 Typical values 4 Notes 5 See alsoHurdle rate determination editThe hurdle rate is usually determined by evaluating existing opportunities in operations expansion rate of return for investments and other factors deemed relevant by management As an example suppose a manager knows that investing in a conservative project such as a bond investment or another project with no risk yields a known rate of return When analyzing a new project the manager may use the conservative project s rate of return as the MARR The manager will only implement the new project if its anticipated return exceeds the MARR by at least the risk premium of the new project A risk premium can also be attached to the hurdle rate if management feels that specific opportunities inherently contain more risk than others that could be pursued with the same resources A common method for evaluating a hurdle rate is to apply the discounted cash flow method to the project which is used in net present value models The hurdle rate determines how rapidly the value of the dollar decreases out in time which parenthetically is a significant factor in determining the payback period for the capital project when discounting forecast savings and spending back to present day terms Most companies use a 12 hurdle rate which is based on the fact that the S amp P 500 typically yields returns somewhere between 8 and 11 annualized Companies operating in industries with more volatile markets might use a slightly higher rate in order to offset risk and attract investors The hurdle rate is frequently used as a synonym of cutoff rate benchmark and cost of capital Different organizations might have slightly different interpretations so when multiple organizations e g a startup company and a venture capital firm are discussing the suitability of investing in a project it is important that both sides understanding of the term are compatible for this purpose 2 The hurdle rate is always higher usually significantly than the cost of capital since generally no project is undertaken by a for profit entity that does not have an expected rate of return higher than the cost of capital i e a profit and every project has risk which must be compensated for Project analysis editWhen a project has been proposed it must first go through a preliminary analysis in order to determine whether or not it has a positive net present value using the MARR as the discount rate 1 The MARR is the target rate for evaluation of the project investment This is accomplished by creating a cash flow diagram for the project and moving all of the transactions on that diagram to the same point using the MARR as the interest rate If the resulting value at that point is zero or higher then the project will move on to the next stage of analysis Otherwise it is discarded The MARR generally increases with increased risk Typical values editThe MARR is often decomposed into the sum of the following components range of typical values shown 3 Traditional inflation free rate of interest for risk free loans 3 5 Expected rate of inflation 5 The anticipated change in the rate of inflation if any over the life of the investment Usually taken at 0 The risk of defaulting on a loan 0 5 The risk profile of a particular venture 0 5 and higherNotes edit a b Park Chan S 2007 Contemporary Engineering Economics 4th ed Prentice Hall p 216 ISBN 978 0 13 187628 6 Ross Stephen A Westerfield Randolph W Jaffe Jeffrey Corporate Finance Seventh Edition McGraw Hill International Edition 2005 Page 330 Lang Hans J Merino Donald N 1993 The selection process for capital projects New York J Wiley amp Sons ISBN 978 0 471 63425 6 See also editWeighted average cost of capital Cost of capital Internal rate of return Retrieved from https en wikipedia org w index php title Minimum acceptable rate of return amp oldid 1177727849, wikipedia, wiki, book, books, library,
