Definition
Required Rate of Return (Hurdle Rate)
The minimum return an investor demands to justify taking on an investment's risk. In time value of money and valuation contexts, this is what "discount rate" means: the rate (r) used to convert future cash flows to present value in PV, FV, and NPV calculations, and the denominator rate in dividend discount and discounted cash flow models. Viewed as an accept/reject bar for a specific investment, the same figure is called the hurdle rate: an investment is accepted if its IRR exceeds the hurdle rate and rejected if it falls short. Companies commonly use their weighted average cost of capital (WACC) as the hurdle rate for capital-budgeting decisions. This is unrelated to the Federal Reserve's discount rate, which is the rate the Fed charges banks for direct loans, a different concept that happens to share informal terminology.
An investor requires a 7% return to accept a project's risk. A proposed investment has an IRR of 9%. Since 9% exceeds the 7% required rate of return (hurdle rate), the investment clears the bar and should be accepted; the same 7% figure is what gets used as the discount rate to compute the investment's NPV.
The single biggest mix-up: "discount rate" in a time value of money or valuation problem is this required rate of return, NOT the Federal Reserve's discount window rate (a monetary-policy tool with no connection to a specific investment's risk). Also easy to conflate: required rate of return, discount rate, and hurdle rate are the same number viewed three ways (the growth-adjustment rate in a formula, the discounting rate in NPV, and the bar an IRR must clear), while WACC is a specific METHOD companies use to calculate what that number should be, not a synonym for it.
How is Required Rate of Return (Hurdle Rate) tested on the exam?
- Recognizing "discount rate" as the required rate of return in NPV, DCF, and DDM problems, as distinct from the Fed's discount rate
- Applying the hurdle rate framing: accept an investment if IRR exceeds the required rate of return, reject if it falls short
- Identifying required rate of return as the "r" input in present value, future value, and NPV formulas
- Recognizing WACC as a common source for a company's hurdle rate in capital-budgeting decisions
- Distinguishing required rate of return (an investor-specific, risk-based benchmark) from a stated or historical return
Calculation example
Calculation Example
Decision rule: Accept if IRR > required rate of return (hurdle rate); reject if IRR < hurdle rate - Identify the required rate of return (hurdle rate): 8%, based on the firm's WACC
- Identify the project's IRR: 6.5%
- Compare: 6.5% is less than 8%, so the IRR falls short of the hurdle rate
- Because IRR is below the required return, the project's NPV at an 8% discount rate would be negative
Same number, three hats: as the "r" in a present value formula it's the required rate of return; as the rate that shrinks tomorrow's cash flows to today's dollars in a DCF it's the discount rate; as the bar an IRR has to clear it's the hurdle rate. All three names describe one number. The Fed's discount rate is a completely different animal wearing a similar name tag.
Practice questions
Test your understanding with the questions below. Pick an answer to reveal the explanation.
A client reads in the news that "the Fed cut the discount rate" and asks her adviser whether this means the discount rate used to value her stock portfolio just changed too. What is the BEST response?
B is correct. The Fed's discount rate is the rate it charges banks for direct loans from the discount window, a monetary-policy tool. The discount rate used to value her portfolio (in a DCF or dividend discount model) is her required rate of return, based on the risk of her specific holdings, an unrelated figure that just happens to share the same informal name.
A and C incorrectly assume the Fed's rate mechanically drives every rate called a discount rate in finance. D is incorrect; valuation models absolutely use a rate called the discount rate, it's just a different one than the Fed's.
This exact terminology collision is a real, tested trap. The Series 65 exam expects you to keep the Fed's discount rate and the valuation discount rate (required rate of return) fully separate, even though practitioners use the same word for both.
In a discounted cash flow analysis, the discount rate applied to future cash flows represents:
A is correct. In valuation, the discount rate is the investor's required rate of return, the minimum return needed to justify the investment's risk.
B names the Federal Reserve's unrelated monetary-policy rate. C describes a fixed, stated bond feature unrelated to a discount rate. D describes a historical benchmark, not a forward-looking required return.
Recognizing which "discount rate" a question means, based on whether the context is monetary policy or valuation, is a fast, frequently tested distinction.
A firm's weighted average cost of capital is 8%, and it uses this as its hurdle rate. A proposed project has a projected IRR of 6.5%. What should the firm do, and why?
B is correct. The project's IRR (6.5%) is below the firm's 8% hurdle rate (its WACC), so it fails to clear the bar and should be rejected.
A wrongly assumes any positive IRR is sufficient; the IRR must exceed the specific hurdle rate. C ignores that WACC is precisely what set the hurdle rate here. D introduces an unsupported claim; nothing in the scenario suggests the WACC figure itself is invalid.
The Series 65 exam frequently pairs a WACC-based hurdle rate with a project IRR and expects a direct accept/reject comparison, the same mechanic as comparing IRR to any other required rate of return.
All of the following statements about the required rate of return are accurate EXCEPT
B is correct (the EXCEPT answer). The required rate of return has no connection to the Fed's discount window rate; they are unrelated figures that happen to share informal terminology (both are sometimes loosely called a "discount rate").
A is accurate: it's a risk-based minimum return threshold. C is accurate: it's the r used in PV and NPV formulas. D is accurate: hurdle rate is the same figure applied as a decision bar.
This question isolates the exact confusion this term exists to prevent: conflating a valuation concept with an unrelated Federal Reserve policy tool just because both get called a "discount rate" informally.
Which of the following statements about the required rate of return are accurate?
1. It is the same figure as the discount rate in a DCF or dividend discount model
2. It is set directly by the Federal Reserve Board of Governors
3. A company's WACC is commonly used as its hurdle rate
4. An investment should be accepted if its IRR exceeds the required rate of return
B is correct. Statements 1, 3, and 4 are accurate.
Statement 1 is TRUE: the discount rate in a valuation model is the required rate of return. Statement 2 is FALSE: the required rate of return is investor- or firm-specific, based on risk, not set by the Federal Reserve; that describes the unrelated Fed discount rate. Statement 3 is TRUE: WACC is a common source for a firm's hurdle rate. Statement 4 is TRUE: that is the IRR accept/reject decision rule.
Statement 2 is the trap: it borrows a true fact about a different rate (the Fed discount rate) and misattributes it to this one. The Series 65 exam tests exactly this kind of cross-contamination between similarly named concepts.
Where does Required Rate of Return (Hurdle Rate) appear on the Series 65 exam?
This term is tested in the following Series 65 exam topics: