Pioneer Petroleum Case
I. Problem Statement
Pioneer Petroleum is facing the challenge of determining the most effective approach to achieving a minimum rate of return. They currently have two options: using a single cutoff rate based on the company's overall WACC, or implementing multiple cutoff rates based on risk-profit characteristics.
II. Facts and Assumptions
In their capital budgeting process, Pioneer Petroleum only accepts investments with positive net present value.
Currently, Pioneer Petroleum calculates their WACC at 9% as shown in Figure 1 below. When determining the WACC, PPC employs book value weights. However, using market value weights is more practical since it reflects market and investor expectations. This information can guide a company on attracting new capital. Furthermore, Pioneer Petroleum expanded into various markets through mergers with multiple firms.
To
...effectively evaluate their multiple projects, PPC should implement the use of a single corporate cost of capital. This approach allows them to consider the varying risks associated with different industries. While using multiple cutoff rates is another option for Pioneer Petroleum, it may not provide the most accurate information due to the complexity of factors involved in different industries. Therefore, my recommendation for Pioneer Petroleum is to use a single cutoff rate for each individual division.
Instead of analyzing the company as a whole, Pioneer should focus on individual projects. They should consider both the positive net present value and associated risks. The maturity length of the project is another important factor to consider, as younger and older projects tend to have higher risks. By using a single cutoff rate, Pioneer can accurately assess the impact on future decisions.
The WACC (Weighted Averag
Cost of Capital) can be calculated using the formula: Rdebt(1-TC)(D/V) + Requity(E/V) = 9%. In this formula, Rdebt is 12%, TC is 34%, D/V is 0.5, Requity is 10%, and E/V is 0.5 (see Figure 1).
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