Hurdle Rate Analysis for Indian Power Projects

Abstract

Hurdle rate is the minimum rate of return required by the investor. It has generally been observed that setting up of a hurdle rate in power generation projects is done arbitrarily purely on the basis of rules of thumb in Indian scenario. The present study is an effort to empirically link various variables utilized for making judgements on values of hurdle rate and the hurdle rate itself. The various variables used in the study are projects Weighted Average Cost of Capital (WACC), project default premium, projects unconventional risk factor, projects strategic discount factor, projects tenure and expected inflation rate. Various tests were conducted to check suitability of application of ordinary multiple regression. Finally, robust regression was found suitable to be applied depending on the test results. In addition, step-wise ordinary multiple regression was applied to find the relative significance of each applied independent variable. Suggestions are also provided on establishing a robust system of identification of unconventional risk factors as well as strategic discount factor. Lastly, a model has been developed and the relative significance and ways of application of various independent variables have been discussed.

Keywords: Hurdle, Budgeting, Robust, Regression, Heteroskedasticity, WACC

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