Hurdle Rates Presentation

Group 9
RISHABH RAJ 13PGP104

ROHIT ANAND GARG 13PGP105
RUCHITA RAJU BURDE 13PGP106
SILPA BEHERA 13PGP107
SMRUTI PRAKASH 13PGP109

Strategic Hurdle Rates for Capital
Investment

Concept of a single screen Comparison of expected ROI with the companys cost of
capital

Flaws in the concept
1. Single Hurdle Rate
2. Hurdle rate as cost of capital
3. Investment strategy is a bottom up process
TRADITIONAL APPROACH
Unrelated to availability of funds
Presence of no better options on the table
Impossible to apply to all capital outlays Defensive Investment
Single Hurdle Rate
Problem in defining and measuring operationally the companys cost of capital
Funds provided by investment or reinvestment cannot be considered free capital
Cost of equity as an imputed or opportunity cost
Extrapolation and measurement of ROI standard implicit in stockholders payment
Cost of Capital
PROBLEMS ENCOUNTERED
Corporate Opportunity Cost
In Question?
The relevance of cost of capital to determination of the investment hurdle
rate.
Two conclusions are important here:
Corporate opportunity cost should replace the stockholder opportunity cost for
determining the primary hurdle rate.
Differentiation to be made between Strategic and Tactical investment decisions.
Redeployment of Strategic investment fund involves considerable time and uncontrolled
circumstances.

Two Levels of Choice
Strategic Decision Tactical Decision
Policy level decisions that come out of
long range planning
Smaller per individual proposal that
continue the business on an existing
course.

Concerned with deliberate changes
over a long period allowing for major
transformations.
Concerned with near future with
weightage to past decisions and
present scenario.

Hurdle Rate Grid
In reality, the organization is divided into various segments
which work independent of each other, generate their own
income and have their own set of managers.
Hurdle rate should be analysed for different segments of the
economy.
The strategy deals with the aggregate allocation of capital to
the major segments of the business and defines the
proportions and rate of growth of each relative to the others.
Analysing Divisional Hurdle Rate of
ABC Company
Division Name Current ROI
Contribution to
Earnings
A 8% 50%
B 6% 10%
C 10% 25%
D 12% 10%
E 14% 5%
Total 9% 100%
Hurdle Rate = 11%
Tactical Decisions for ABC Company
Few of B divisions proposals are likely to clear the hurdle
and those that clear have little managerial rationale
To sustain B, some minimum capital commitment is
required to maintain current market potential until decisions
are made to liquidate the division.
Hurdle rate needs to be reviewed for the division B because
of several reasons like market conditions or high
competition etc.

Strategic Decisions for ABC Company
Management can decide whether to maintain, sell or liquidate the
division
Decisions are made not on the divisions capability but on the
expected rate of return on other strategic investment alternatives.
Any decision are made considering the returns of other divisions.
Internal Corporate Opportunity Cost Decisions are made
considering the returns of other divisions.
External Corporate Opportunity Cost - Decisions are made
considering the returns of creating new divisions in the
organization.

Stockholders Interest
Where would we consider stockholders options?
Weak management of a weak company
Rationalize investments that reflects the marginal internal
and external options.
Problem lies in:
Either in the set of investment alternatives selected,
related industry and competitive environment
Caliber of its management

Stockholders Interest (contd.)
Possible Solution
Management change
Altering Strategy
Implications
Setting of over optimistic forecasts.
Investment in high risk ventures.
Stockholders Interest (contd.)
When can it benefit?
The top management use it performance standard for
review.
Only in context of Long range planning.
Budget allocation based on strategic hurdle rates ,which can
be on the basis of:
Internal: Returns of the best performing division.
External: Best of many alternatives outside business.

Budget Allocation based on Tactical Hurdle rates should be
on the basis of:
Internal: Overall demonstrated return of division based on realistic
assessment of targets and past performance.
External measure compares with most efficient competitor.

Conclusion

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Group 9

RISHABH RAJ 13PGP104

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