A hurdle rate is the discount rate that must be applied to a projected earnings stream to determine whether the investment is likely to generate a minimally acceptable return. It is usually set by management and approved at the board level in consultation with either the chief investment officer or the chief financial officer. If the expected return does not exceed the hurdle rate, the investment is unlikely to be approved. Most companies set the hurdle rate as equivalent to their own cost of capital.

Special situations then call for documented reasons to add points to the discount rate—for inexperience in the field, for high deviation rates on historical earnings for the target or its industry, size of target, liquidity of the underlying assets, or for other risk-related reasons. For example, executives may develop different hurdle rates for entries into different industries or locations that coincide with the comfort level of the executives’ personal views about them. This approach is not a proper proxy for risk, because those assessing the risk are not necessarily the ones who will be managing the acquisition.