Why do hurdle rates differ from the cost of capital?

Driver, Ciarán; Temple, Paul

doi:10.1093/cje/bep013

Cited by 8 publications

(8 citation statements)

References 41 publications

Supporting

Mentioning

Contrasting

Unclassified

Order By: Relevance

“…In fact, we find that it is optimal for the principal to commit to continue some projects at Stage 2 even if they have a negative continuation value (i.e., Stage 2 over--investment), while it is also optimal to commit to forego other projects that have a positive continuation value (i.e., Stage 2 under--investment). Our results are consistent with the empirical evidence of both over and under--investment across firms found by Richardson (2006) and Driver and Temple (2009). However, our results are most closely related to Poterba and Summers (1995) who find multiple hurdle rates within individual firms, some of which are below and some of which are above their cost of capital.…”

Section: Introductionsupporting

confidence: 92%

Multistage Capital Budgeting with Delayed Consumption of Slack

2013

View full text Add to dashboard Cite

Capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects. In this paper, we study a project requiring two stages of investment. Failure to fund Stage 1 of the investment precludes investment in Stage 2, whereas failure to fund Stage 2 results in early termination. In contrast to the existing literature, we assume that the firm can limit the manager's informational rents with the early termination of the project. In this setting, we find that the firm optimally commits to a capital allocation scheme whereby it forgoes positive net present value (NPV) projects at Stage 1 (capital rationing), whereas at Stage 2, depending on the manager's previous report, it sometimes implements projects with a negative continuation NPV but in other situations forgoes implementing projects with positive continuation NPVs. Capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects. In this paper, we study a project requiring two stages of investment. Failure to fund Stage 1 of the investment precludes investment in Stage 2, whereas failure to fund Stage 2 results in early termina--tion. In contrast to the existing literature, we assume that the firm can limit the manager's informational rents with the early termination of the project. In this setting, we find that the firm optimally commits to a capital allocation scheme whereby it foregoes positive NPV projects at Stage 1 (capital rationing), while at Stage 2, depending on the manager's previous report, it sometimes implements projects with a negative continuation NPV but in other situations foregoes implementing projects with positive continu--ation NPVs.

show abstract

Section: Introductionsupporting

confidence: 92%

Multistage Capital Budgeting with Delayed Consumption of Slack

2013

View full text Add to dashboard Cite

show abstract

“…However, it is hard to square with the failure to find any direct positive role for governance. An alternative explanation is that an increased level of governance breaks any link between R&D intensity and cash flow by raising hurdle rates for R&D in favour of increased dividend pay-out ratios (Lazonick 2008;Driver and Temple 2010). This implies that the demand for R&D finance falls as a result of board strategy, eliminating any constraint, though any improvement in the terms on which finance is available is irrelevant.…”

Section: Hypothesis H2mentioning

confidence: 99%

Research and development, cash flow, agency and governance: UK large companies

Driver¹,

Guedes²

2012

Research Policy

View full text Add to dashboard Cite

show abstract

“…Step-by-step iterational calculation of r effective (IRR) for the project's earmarked CFs Presentation of pre-estimated credit terms: the set of the CFs drawn by lender from the borrower's proposed pool of CFs; the credit length (T); the effective interest rate. No indirect lender's preferences (4). The potential borrower's data analysis (2) shows that the loan complies with the necessary (3) and sufficient (5) criteria.…”

Section: Yes Input Datamentioning

confidence: 99%

“…A loan application can be accepted for the following processing ( 8) only due to the lender's preferences. No indirect lender's preferences (4). The potential borrower's data analysis (2) shows that the loan does not comply with the necessary criterion (3).…”

Section: Yes Input Datamentioning

confidence: 99%

Prior credit assessment of long-term SME projects with non-standard cash flows

Onikiienko

Polishchuk

Ivashchenko

et al. 2021

Banks and Bank Systems

View full text Add to dashboard Cite

Over the past three decades, the relative bank loan demand has changed due to the arising small and medium-sized enterprises (SMEs). Therefore, banks in their operations face the problem of processing an ever-increasing number of loan applications. The aim of this paper is to develop an auxiliary approach to assessing the prior creditworthiness of long-term SME projects with nonstandard cash flows.This study reveals how the principles of value-based management can be incorporated into the process of borrower’s creditworthiness assessment to improve the process of screening loan applications. For this, the internal rate of return was used as a criterion for loan granting decision at the initial stage of loan underwriting.An algorithm for the preliminary evaluation of loan applications is proposed and is based on the principle of maximizing the shareholder value of banks. This algorithm helps to define the credit terms taking into consideration the distribution of positive cash flows throughout the project’s expected economic life, calculate the possible real effective interest rate concerning the borrower’s nonstandard cash flow schedule, make a rough analysis on the economic efficiency of lending and state the necessary criterion to initiate the procedure of loan underwriting for the projects with nonstandard cash flow schedules. The proposed estimation algorithm stemming from the IRR-approach for the cash flow analysis can also be initially used by a borrower as a tool for credit solvency self-testing via screening of periods with corresponding cash flows that can be used for loan servicing.

show abstract

Why do hurdle rates differ from the cost of capital?

Cited by 8 publications

References 41 publications

Multistage Capital Budgeting with Delayed Consumption of Slack

Multistage Capital Budgeting with Delayed Consumption of Slack

Research and development, cash flow, agency and governance: UK large companies

Prior credit assessment of long-term SME projects with non-standard cash flows

Contact Info

Product

Resources

About