In corporate finance, money's time value plays a crucial role in evaluating a project's expected profitability. Because the value of a dollar earned today is greater than its value when earned a year from now, businesses discount the value of future revenues when calculating a project's estimated return on investment. Two of the most commonly used capital budgeting tools that utilize discounted cash flows are net present value, or NPV, and internal rate of return.
For any projects that businesses pursue, they determine a minimum acceptable rate of return, called the hurdle rate, which is used to discount future cash flows in the NPV calculation. Companies often use the weighted average cost of capital, or WACC, as the hurdle rate in capital budgeting because it represents the average cost of each dollar used to fund the project. Projects with the highest NPV figures are generally pursued because they are likely to generate income that far exceeds the cost of capital. Conversely, a project with a negative NPV should be rejected, because the cost of funding exceeds the present value of its returns.
The IRR is the discount rate at which the NPV of a given project is zero. This means the total discounted revenues are exactly equal to the initial capital outlay. If a project's IRR exceeds the company's hurdle rate or WACC, the project is profitable.
For example, assume a project requires an initial investment of $15,000 and generates revenues of $3,000, $12,500 and $15,000 over the next three years, respectively. The company's WACC is 8%. Using the average cost of capital as the hurdle rate, this project's NPV is ($3,000 / ((1 + 0.08) * 1)) + ($12,500 / ((1 + 0.08) * 2)) + ($15,000 / ((1 + 0.08) * 3))  $15,000, or $10,402. Such a strong NPV indicates this is a highly profitable project that should be pursued. In addition, the IRR calculation yields a rate of 35.7%. This project's profitability is confirmed because the IRR far exceeds the hurdle rate.

How much debt is too much when calculating capital budgeting?
Learn how companies determine how much debt is acceptable when funding a new project by using the net present value to estimate ... Read Answer >> 
How do you calculate IRR in Excel?
Understand how to calculate the internal rate of return (IRR) in Excel and how it's used to determine anticipated yield per ... Read Answer >> 
How do I use Excel to get discount rate over time?
Learn how to calculate discount rate in Microsoft Excel and how to find the discount factor over a specified number of years. Read Answer >> 
What is the difference between the cost of capital and the discount rate?
Learn about the differences between the cost of capital and the discount rate as they relate to estimating a required return ... Read Answer >> 
What's the difference between net present value and internal rate of return? How ...
Both of these measurements are primarily used in capital budgeting, the process by which companies determine whether a new ... Read Answer >> 
What is the difference between present value and net present value?
Understand the difference between the present value and net present value calculations and how these formulas are used in ... Read Answer >>

Managing Wealth
What's a Hurdle Rate?
Hurdle rate has two meanings. In the business world, a business typically makes a decision on a capital project based on the net present value approach. To determine the net present value, the ... 
Investing
Return on Investment (ROI) Vs. Internal Rate of Return (IRR)
Read about the similarities and differences between an investment's internal rate of return (IRR) and its return on investment (ROI). 
Financial Advisor
A Guide on the RiskAdjusted Discount Rate
When a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the riskadjusted discount rate. 
Financial Advisor
Understanding Internal Rate Of Return
Internal rate of return, or IRR, is one of the most popular methods of evaluating potential projects. Learn more about this important metric. 
Small Business
Capital Budgeting
Capital budgeting is a planning process used by companies to evaluate which large projects to invest in, and how to finance them. It is sometimes called â€śinvestment appraisal.â€ť 
Investing
Investors Need A Good WACC
Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality. 
Investing
How to Calculate Required Rate of Return
Investors use the required rate of return to decide where to put their money, and corporations use it to decide if they should pursue a new project.

IRR Rule
A measure for evaluating whether to proceed with a project or ... 
The Net Internal Rate Of Return  Net IRR
A measure of a portfolio or fund's performance that is equal ... 
Weighted Average Cost Of Capital  WACC
Weighted average cost of capital (WACC) is a calculation of a ... 
Present Value  PV
The current worth of a future sum of money or stream of cash ... 
Net Present Value Rule
A rule stating that an investment should be accepted if its net ... 
Discount Rate
Discount rate is the interest rate charged to commercial banks ...