A:

The hurdle rate is defined as the minimum rate of return required on a project to cover costs and stay profitable. In different firms and industries, this may differ tremendously. A hurdle rate may be a fixed percentage return that financial firms require before making an investment, for example. Firms in other industries, such as an IT company, may have a fixed cost associated with each type of project and a minimum amount of profit. Any project that is less profitable than the hurdle rate is rejected as not profitable enough for the business. Many businesses set hurdle rates to determine if a particular project is worthy of company resources. Hurdle rates keep businesses profitable and competitive.

For financial firms, the hurdle rate on an investment may be a minimum return that a hedge fund manager or other financial professional must obtain before becoming eligible to receive a performance incentive. This encourages financial professionals to choose profitable investments.

Hurdle rates may be tailored to different risk levels, investment types, investment locations or other characteristics. As interest rates change, hurdle rates also change to maintain a profitable investing level. If the hurdle rate is too high, the firm may reject too many investments and miss out on revenue. A low hurdle rate risks bringing a project over budget and losing profitability for the firm. Low-risk projects typically offer investors a lower return. The risk-return tradeoff necessitates a hurdle rate that carefully considers the risk level and seeks a higher return for high-risk investments.

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