Case Pioneer Petroleum
Case Pioneer Petroleum
This case discusses the calculation of hurdle rates and the use of single vs. multiple hurdle rates.
1. You are tasked with calculating the required rate of return for Pioneer’s investments. Start with the CAPM.
a. What is the average excess return on the market portfolio over 1980-1990?
b. What are the disadvantages of using historic returns to calculate the CAPM? Give at least two reasons why expected returns may be calculated incorrectly when using historic returns to calculate CAPM.
c. What is the latest risk-free rate?
d. What is the required rate of return of Pioneer’s equity?
e. What is Pioneer’s WACC after taxes?
f. Suppose an investment opportunity arises that has a similar risk profile as the existing operations of Pioneer. If the project has an internal rate of return of 10%, would you expect Pioneer to accept it? Should the project be accepted? Assume leverage is unchanged by the new project.
2. Single vs multiple hurdle rates
a. Should you always invest in the project with the highest return? Why (not)?
b. Suppose Pioneer faces an investment decision and can invest in a pipeline with a return of 10% or in a new oilfield with a return of 15%. Suppose Pioneer uses the WACC you calculated in the previous exercise to evaluate the viability of new projects. Which project would it invest in?
c. Should the WACC of the entire company be used to evaluate investment decisions?
d. Now, suppose the pipeline project has a beta of 0.5 and the oil field has a beta of 2. What are the relevant discount rates to both projects? Use the information that you collected in exercise 1 to calculate hurdle rates.
e. Which projects should Pioneer invest in?
This case discusses the calculation of hurdle rates and the use of single vs. multiple hurdle rates.
1. You are tasked with calculating the required rate of return for Pioneer’s investments. Start with the CAPM.
a. What is the average excess return on the market portfolio over 1980-1990?
b. What are the disadvantages of using historic returns to calculate the CAPM? Give at least two reasons why expected returns may be calculated incorrectly when using historic returns to calculate CAPM.
c. What is the latest risk-free rate?
d. What is the required rate of return of Pioneer’s equity?
e. What is Pioneer’s WACC after taxes?
f. Suppose an investment opportunity arises that has a similar risk profile as the existing operations of Pioneer. If the project has an internal rate of return of 10%, would you expect Pioneer to accept it? Should the project be accepted? Assume leverage is unchanged by the new project.
2. Single vs multiple hurdle rates
a. Should you always invest in the project with the highest return? Why (not)?
b. Suppose Pioneer faces an investment decision and can invest in a pipeline with a return of 10% or in a new oilfield with a return of 15%. Suppose Pioneer uses the WACC you calculated in the previous exercise to evaluate the viability of new projects. Which project would it invest in?
c. Should the WACC of the entire company be used to evaluate investment decisions?
d. Now, suppose the pipeline project has a beta of 0.5 and the oil field has a beta of 2. What are the relevant discount rates to both projects? Use the information that you collected in exercise 1 to calculate hurdle rates.
e. Which projects should Pioneer invest in?