Sample frameDay 156·Finance · Capital

Morning. Spending the money isn't the decision. The return you refuse to go below is.

Finance.

The Hurdle Rate

5 min read·Apply by lunch

The question

When you last approved a spend of real consequence — the hire, the fit-out, the second location, the new market — what return did it have to clear before it earned the yes, and if you can't name that number or say what it's built from, why haven't you set it, given that every approval you've ever signed used one silently anyway?

The idea

In 2001 John Graham and Campbell Harvey, both finance professors at Duke, published 'The Theory and Practice of Corporate Finance: Evidence from the Field' — a survey of 392 chief financial officers about what they actually do rather than what the textbooks prescribe. Roughly three in four said they always or almost always appraise projects using net present value and internal rate of return, which reads like discipline until you reach the next finding: a majority applied one company-wide discount rate to every project whatever its risk, so the routine replacement of a machine and a first attempt at an overseas market were judged against the same number. The hurdle rate is the most consequential number a business sets, because it decides which future the money buys. One ordinary way to get it wrong is not having a rate at all, so every approval gets argued on enthusiasm. The trap is the other one: a rate you inherited rather than built, carried for years because a director once said it, and applied with a straight face to a forklift and a new country alike.

The framework

01
Build the number out of what your capital actually costs.
Money arrives at two prices. Debt is the visible one: it has an invoice, a rate you can read off the loan, and interest that reduces tax, so its true cost sits below the headline. Equity is the expensive one and it never invoices you, which is exactly why it gets treated as free. Weight the two by how the business is genuinely funded and you've got a floor under every decision you make. Quote your loan rate as your cost of capital and you've priced only the cheap half of the money — a floor built that low waves through almost anything.
02
A forklift and a new country are not the same bet.
Replacing a machine on a line that's run for six years and opening a market where you've never sold anything carry entirely different risk, and a single corporate rate systematically overfunds the wild one while starving the safe one. Don't chase decimals. Keep a short ladder — maintain, core growth, adjacency, genuinely new — with a visible step between the rungs, and assign every proposal to a rung before anybody opens a spreadsheet. The order matters more than the rate: build the model first and the rung gets chosen to suit the answer.
03
When money is short, the bar is the best thing you cannot fund.
Cost of capital tells you what money costs. It doesn't tell you what money is worth when there isn't enough of it. If eleven proposals want funding and you can back three, clearing your weighted cost of capital means nothing, because the real bar is the return on the fourth-best thing in the queue. Rank first, fund down, and let the first unfunded proposal set the number everything else has to beat. Without that discipline the bar gets set by arrival time, and a mediocre project in March quietly outranks a strong one in November.
04
Publish the rate, and let it refuse things.
A hurdle rate is worth precisely what it stops. Two things kill it. One is the movable bar, dropped a few points for the sponsor with standing, which teaches everyone that the number is a negotiation. The other is the inflated bar — thirty per cent set for safety — which teaches everyone to pad their forecasts until they clear it, so you finish with two distortions pointing in opposite directions and no way to read the truth through either. Set it once a year in writing with the workings attached, and change it when the cost of money changes, not when a proposal you like falls short.

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