How is the hurdle rate (hAT) calculated?

The hurdle rate, often referred to in the context of investment and financial performance evaluations, represents the minimum acceptable return that an investor expects to earn before committing to an investment. It serves as a critical benchmark in assessing the viability of projects or investments.

The correct calculation of the hurdle rate is captured by the formula which includes the weighted average cost of capital (WACC), integrating both the cost of equity and the cost of preferred equity proportionally based on their respective weights in the capital structure. The formula expresses this concept by taking the weighted average of the costs in relation to their proportional capital contributions.

In the approved answer, the hurdle rate is determined by summing the products of the costs of each capital component (equity and preferred equity) weighted by their respective shares in the overall capital structure. The formula, thus, reflects the average cost of financing that needs to be exceeded to make the investment worthwhile. It adequately represents the total financial risk of the investment, ensuring all sources of capital are considered appropriately.

Other formulas provided do not accurately capture the weighted average perspective necessary for determining the hurdle rate. Some may misinterpret the relationships between the components or omit key factors contributing to the overall cost of capital. This precision is why the selected formula is the appropriate one