Question

Which of the following is a legitimate reason for firms to use a hurdle rate rather than an estimated WACC to evaluate projects?

Question 9 options:

	A) To more closely represent true opportunity costs for a firm that has to reject positive-NPV projects due to financial constraints.
	b) To provide a safety margin in case of estimation error in the WACC.
	C) Both of the above reasons are valid.
	D) Firms only use a hurdle rate different from the WACC out of ignorance of financial theory.
	E) Firms never use a "hurdle rate."

Answer 1

The Correct option is A

Hurdle rate refers to the Minimun acceptable rate of return, it shows the minimun return that the company expects from the project to generate and it is mostly demanded by the investors. It shows the opportunity cost which the company can forego other projects.

The company can use the hurdle rate to determine the rate of return that the project gives and can determine on the basis of risk and return which project should be choose while WACC assumes that there is no change in capital structure and the risk in new projects which makes to harder to compare the correct opportunity cost and desired rate of returns.