Pioneer
2. Case: Pioneer Petroleum
Note that p.2 of the case incorrectly states that the firm’s debt policy is that debt should comprise 50% of its total capital structure, defined as “long-term debt plus book equity.” The correct text should state “long-term debt plus market equity.”
Answer the following questions:
a. Does Pioneer estimate its overall corporate weighted-average cost of capital correctly?
I think they´re WACC is correctly estimated. They use 50% debt and 50% equity, which I think is very risky. I would prefer to use a 40% debt and a 60% equity in that way the company would be less riskier. Although I’m not an expert in this type of companies.
b. Should Pioneer us a single corporate cost of capital, or multiple divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined?
I think the best way for pioneer to evaluate all of their projects would be to use a WACC for every division in their company, because not all of their projects has the same risk, neither the same CAPM, etc. Making different WACC make it harder for the company for to evaluate the rate of return, maybe that’s why they don’t do this.
c. How should Pioneer set capital budgeting criteria for different projects within a given division? What distinctions among projects might be captured in these criteria? How should these different standards be determined?
I think every division should need to manage their risk, especially how much debt they acquire because I don’t think all divisions use a 50% debt. I think very few divisions use more than 50% debt and those are the divisions that are the most risky of all. Those divisions should need to have a special check because if something goes wrong, they can break all the company.
d. Should you use WACC only for projects that are carbon copies of the firm?
I think all type of projects should use WACC, it just depends on which WACC you´re using, or which D/E
Note that p.2 of the case incorrectly states that the firm’s debt policy is that debt should comprise 50% of its total capital structure, defined as “long-term debt plus book equity.” The correct text should state “long-term debt plus market equity.”
Answer the following questions:
a. Does Pioneer estimate its overall corporate weighted-average cost of capital correctly?
I think they´re WACC is correctly estimated. They use 50% debt and 50% equity, which I think is very risky. I would prefer to use a 40% debt and a 60% equity in that way the company would be less riskier. Although I’m not an expert in this type of companies.
b. Should Pioneer us a single corporate cost of capital, or multiple divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined?
I think the best way for pioneer to evaluate all of their projects would be to use a WACC for every division in their company, because not all of their projects has the same risk, neither the same CAPM, etc. Making different WACC make it harder for the company for to evaluate the rate of return, maybe that’s why they don’t do this.
c. How should Pioneer set capital budgeting criteria for different projects within a given division? What distinctions among projects might be captured in these criteria? How should these different standards be determined?
I think every division should need to manage their risk, especially how much debt they acquire because I don’t think all divisions use a 50% debt. I think very few divisions use more than 50% debt and those are the divisions that are the most risky of all. Those divisions should need to have a special check because if something goes wrong, they can break all the company.
d. Should you use WACC only for projects that are carbon copies of the firm?
I think all type of projects should use WACC, it just depends on which WACC you´re using, or which D/E