Which of the statements below is true? A. The hurdle rate is the cost of debt ne

Question

Which of the statements below is true?

A. The hurdle rate is the cost of debt needed to fund a project.

B. If the IRR exceeds a project's hurdle rate, the project should be rejected.

C. If the IRR clears the hurdle rate, the project is rejected.

D. The hurdle rate should be set so that it reflects the proper risk level for the project.

A. The hurdle rate is the cost of debt needed to fund a project.

B. If the IRR exceeds a project's hurdle rate, the project should be rejected.

C. If the IRR clears the hurdle rate, the project is rejected.

D. The hurdle rate should be set so that it reflects the proper risk level for the project.

Explanation / Answer

Hurdle rate is the minimum required rate of return, that company has to earn from a project. While calculating it company has to consider all sources of funds for investment in the project. Automatically it will take into consideration all risks associated with the project. The hurdle rate should be adequate enough to cover the project risk.

Internal rate of return (IRR) is the actual return that project will yield. It should be at least equal or higher than the project. Then project will be accepted.

Now consider different options of the problem. In point A. hurdle rate is the cost of debt needed to fund the project. It is not totally true. No doubt debt is needed to fund a project. Also equity and other sources are used in their funding. So risk of project is the total of all sources of fund.

Next statement (B) states that IRR exceeds project hurdle rate. So it should be accepted. But this statement is saying that project should be rejected. It is not true.

Third statement (c) is also wrong. Here IRR clears the hurdle rate. So project should be accepted. again this statement is saying that project is rejected. So it is also wrong.

Fourth statement (D) states that hurdle rate should be set so that it reflects the proper risk level for the project. Thus statement (D) is correct.

Answer: D is correct

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