Cut off rate is the minimum rate which will be received by investor, if he invests his money. It is just like cost of capital or return on investment. But it is not sure that investor will invest his money at cut off rate because, investor will deeply analyze his investment proposals with different capital budgeting techniques. One of important technique is IRR in which cut off rate is compared with internal rate of return and if any project’s IRR will more than cut off rate, then that project will be accepted.
Many other techniques like NPV and P.I. in which we use cut off rate for calculating the present value of cash outlay and cash inflows.
Following are the major factors which affects cut off rate's determination :-
1. Amount of Investment
Cut off rate is the standard rate and it affects investment decisions. Amount of investment affects cut off rate’s determination. If investment amount is very high in any investment projects, then its cut off rate will be more than 10%.
2. Period of Investment
If any investment project offers to pay the amount of investment in installments, then cut off rate will be very small but if investor has to pay all amounts within one installment, then cut off rate may be very high.
3. Risk factor
If there is high risk with investment, then cut off rate will be high. If there is no risk of money, then investor can invest the money at very low cut off rate.