A previous paper in this journal discussed how to estimate the appropriate rate that should be used to evaluate investment projects. In this paper, the same theme is extended to discuss why projects might attract hurdle rates that are higher than the cost of capital. The answer involves discussion of the topic of real options, which may provide a rigorous explanation of how companies can value flexibility in capital budgeting. This paper discusses the gap between the hurdle rate and the cost of capital and explores possible explanations for the rational use of additional barriers before accepting capital projects.
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