What is MARR; how it is determined

What is MARR

The Minimum Attractive Rate of Return (MARR) is the lowest rate of return that a company will accept to invest in a project. A project is accepted only if its IRR (or ERR) ≥ MARR, and the MARR is used as the interest rate in PW, FW, AW and B/C calculations. It is also called the hurdle rate or cut-off rate.

How it is determined

1. Cost of capital. MARR must be at least the weighted average cost of capital (WACC): the cost of debt (loan interest, after tax) and the cost of equity (dividend and growth expected by owners), weighted by their share in the capital.
2. Opportunity cost. It must not be below the return from the best alternative use of the money (for example, bank fixed deposit, government bonds, or other projects that must be dropped when funds are limited).
3. Risk premium. A risk allowance is added: MARR = risk-free rate + risk premium. Risky projects (new product, new technology) get a higher MARR than safe ones (cost reduction, replacement).
4. Inflation. The rate should cover expected inflation so that the real return remains positive.
5. Capital rationing and policy. When funds are limited, MARR is raised until the accepted projects just use the available budget. Management policy and the investment horizon also affect it.

For a company and for a project

• Company MARR: a single base rate (usually WACC plus a margin) for the whole firm.
• Project MARR: the company rate adjusted for the project's own risk, life and type: MARR(project) = base MARR + project risk premium.

Example: bank loan at 12%, owner expects 18% on own money, 50:50 mix gives WACC = 15%; adding 3% for risk gives MARR = 18%.