Question

Assume that your assigned firm is considering a new 4-year project that would require a $1,000,000 initial investment in equipment including shipping and installation. The equipment would be depreciated using 3-year MACRS. 3-year MACRS allows firms to depreciate qualifying assets over four years at rates of 33.33%, 44.45%, 14.81% and 7.41% for years one through four respectively. The equipment can be sold at the end of the project for $250,000. Assume that the project would also require a $100,000 investment in net working capital. Your firm is forecasting that they would sell 10,000 units of the new product at $100 each in the first year and those sales would increase by 30% each year. Cost of goods sold on this new product would be 60%. Selling, general and administrative expenses to this investment are fixed at $250,000 per year. Calculate your firm’s effective tax rate (we are going to use 20% which indicates the statutory rate). Using 12% as your firm’s estimated/required return, answer the following question: (NPV = $93,147.58 IRR = 15.14% Payback of the project = 3.29 Discounted payback = 3.82 The firm SHOULD accept the project because NPV is positive)

QUESTION: How does the hurdle rate (12%) compare to the firm’s ROE and ROA?

I already know NPV, IRR, Payback, etc, please post the answer to this last question please about hurdle rate!!!

Answer 1

A hurdle rate is the minimum rate of return on a project or investment required by an investor.The hurdle rate denotes appropriate compensation for the level of risk present riskier projects generally have higher hurdle rates than those that are deemed to be less risky.In capital budgeting,projects are evaluated either by discounting future cash flows to the present by the hurdle rate, so as to ascertain the net present value of the project, or by computing the internal rate of return (IRR) on the project and comparing this to the hurdle rate. If the IRR exceeds the hurdle rate, the project would most likely proceed.

In the given problem it has been clearly seen that the desired rate of return is 12% which is same as equal to hurdle rate.We make assumption in this case that this will be the minimum required rate of return of the firm. A company with a hurdle rate of 12% for acceptable projects would most likely accept a project if it has an internal rate of return of 15.14% and does not have a significantly higher degree of risk. Alternately, discounting the future cash flows of this project by the hurdle rate of 12% would lead to a large and positive net present value i.e $93,147.58,which would also lead to the project's acceptance.

NOTE: In the given case hurdle rate can also gets compare with ROA and ROE,but it can also be compare with IRR for making conclusions for acceptance of projects.