A Practical Approach to Business Unit Hurdle Rates, Portfolio Analysis and Strategic Planning
Othmar Lehner, Editor, Proceedings in Finance and Risk Series ’14: Academic Collaboration and Research Network (Austria: ACRN Publishing, 2014), pp. 124-138.
Posted: 11 Jan 2015
Date Written: December 31, 2014
During the course and scope of our work as corporate finance advisors and researchers we have encountered a number of executives who struggle with their current methods of estimating business unit hurdle rates, and their methods of evaluating business unit portfolios. A number of these executives subjectively picked a hurdle rate -- many times between 10 to 15% -- without engaging in any form of analysis. Worse, some employed formal analysis merely to "back into" a desired hurdle rate. To address situations like these, we adopt a well-known financial model and modify it for use in a business unit context through the use of a strategic accounting beta. Significantly, we also recast and simplify the mathematical expression of the model, which provides a level of transparency to the model that makes it easier for corporate finance and strategy executives to understand and therefore use. It also facilitates a practical form of portfolio analysis, which can be used in conjunction with various capital budgeting methods to question certain strategically significant assumptions, as well as to inform and direct more mathematically rigorous forms of analyses. The linkage between the two approaches -- hurdle rate estimation and portfolio analysis -- was found to be very useful in strategic planning processes where, in order to secure the requisite funds to execute a business strategy, the objective is to show how a business unit can meet (and hopefully exceed) a given hurdle rate.
Keywords: Hurdle Rates, Portfolio Analysis, Strategic Planning, Capital Allocation
JEL Classification: G30; G31; L10; L11
Suggested Citation: Suggested Citation