In evaluating a capital project, which statement best describes what the hurdle rate accounts for?

• A. Risk and opportunity cost of capital.
• B. Inflation only.
• C. Depreciation expense.
• D. Tax credits.

Answer: (A)

The hurdle rate is the minimum return a project must earn to be acceptable, reflecting two core ideas: the risk of the project and the opportunity cost of using capital elsewhere. In practice, this means the rate is tied to the company’s cost of capital and is adjusted upward for higher risk so that a project only proceeds if its expected returns compensate for that risk and for what investors could earn with similar risk investments. Depreciation is a non-cash expense and doesn’t set the discount rate. Tax credits affect after-tax cash flows but don’t determine the hurdle rate itself. Inflation can be embedded in the nominal rate, but the essential purpose of the hurdle rate is to capture risk and the foregone opportunities when choosing this project over alternatives.