Pioneer Petroleum Case I. Statement of Problem As Pioneer Petroleum continues to progress as a company, they are trying to determine the best way to approach a minimum rate of return. As of right now, they have two approaches they can take. The first would be taking a single cutoff rate based on the company’s overall WACC. The second, rather than a single cutoff, there would be multiple cutoff rates due to the risk-profit characteristics. II. Statement of Facts and Assumption Pioneer Petroleum’s approach to capital budgeting was to only accept investments with positive net present value.
Currently, Pioneer Petroleum calculated their WACC at 9% shown in Figure 1 below. In calculating their WACC, PPC uses book value weights. When dealing with practicality, it is better to use market value weights because it provides what the expectations of the market and the investors have. By using this information, it can show what a company needs to do to gain new capital. III. Analysis Pioneer Petroleum was created after merging with multiple firms causing it to branch out into different markets.
With multiple projects, the most effective thing PPC could do is to implement using single corporate cost of capital to evaluate their multiple projects. By doing this they can interpret different risk associated with different industries. Pioneer Petroleum’s other option would be to use multiple cutoff rates, but going in this direction may not provide the most accurate information since there are many components associated with different industries. IV. Recommendation My recommendation for Pioneer Petroleum would be to use a single cutoff rate and each individual division.
It would be wise for them to do this rather than looking at the company as a whole. Not only should Pioneer only invest in projects with positive net present value, but they also need to assume the different risks associated with it. Something else they might consider is the length of the maturity for the project. More risk could be found in younger projects and older projects as well. By using a single cutoff rate, they can analyze more precisely how much it will effect their decisions in the future. Figure 1 WACC = Rdebt(1-TC)(D/V) + Requity(E/V) 9% = . 12(1-. 34)(. 5) + (. 10)(. 5)
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