Pioneer Petroleum 1

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TO: VEFA TARHAN, SPECIAL TOPICS IN FINANCE FROM: MAHMUT MACIT, AHMET ARDA ATIK, CAN KORKMAZ DATE: NOVEMBER 4, 2014 CASE: PIONEER PETROLEUM CORPORATION Overview of the Company Pioneer Petroleum Corporation established in 1924 and operating in oil refining, pipeline transportation, and industrial chemical fields. Company uses weighted-average cost of capital (WACC) as a discount rate to discount future cash flows that generate from possible projects. According to net present values of these possible projects management decides to invest or not. WACC represents the minimum rate of return from the investments to satisfy both debt-holders (bondholders) and shareholders. Since these investments are forward-looking, company should calculate…show more content…
We support that Pioneer should use CAPM instead of DDM for cost of capital calculations. The main reason behind that is the volatile growth rate of Pioneer Petroleum. According to the Exhibit 1, we found that the earnings per share of the company are highly volatile between 1980-90, which is directly affects the growth rate of dividends paid by the company. Since the operations of the firm is high sensitive to price changes in oil, it is hard to determine a stable growth rate for DDM. We support that CAPM will give more accurate WACC compare to both current calculation method (E/P) and DDM. Table 1 % E/P CAPM DDM* Cost of Equity 10 14,68 14,28 Cost of Debt 7,9 7,9 7,9 WACC 9 11,29 11,09 * Po = $63, Dı = 2,695, g = 0,10 Firm Wide versus Divisional WACC According to our calculations, we support that company should use CAPM to calculate cost of equity and it makes WACC %11,29 for firm-wide cost of capital. Also, we believe that this rate is not sufficient to make decisions for all possible projects and investments. Pioneer Petroleum makes investments in different sectors and industries and this brings different risks for each projects. Higher-risk projects requires a discount rate that is higher than the WACC and lower risk projects requires a discount rate that is lower than the current one. Therefore, company should not use firm-wide cost of capital for all investment

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