Pioneer Petroleum

1250 Words Mar 18th, 2014 5 Pages
Taylor Anderson

INTRODUCTION
Background
Pioneer Petroleum was founded in 1924, through a merger within industrial, pipeline transportation, and refining fields. PP has evolved over the last 60 years into a company that now also works with agricultural chemicals, plastics, and real estate development concentrating in gas, oil, petrochemicals, and coal. In 1990, PP improved their coker and sulfur recovery facility to make their refining process more efficient and in turn has become one of the lowest cost refiners on the West Coast. Due to the refining process PP’s gasolines are among the most cleanest-burning in the industry. PP’s is also the producer of one-third of the world’s supply of methyl tertiary butyl ether (MTBE), which is a
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68-69) | Ki=7.8%+(16.25%-7.8%)0.8 | Ki=14.56% |

Weighted average cost of capital | | | | | | | | | | Kw=KD(WtD)+Ki(Wti), where WtD=50% and Wti=50% (p.66) | Kw=7.92%(50%)+14.56%(50%) | Kw=11.3% |

Analysis of Alternatives In recalculating PP’s WACC correctly their actual average cost of capital came out to be 11.3% as opposed to the 9% that PP has calculated. This shows that PP underestimated their WACC by 2.3% due to the fact that they set equity at 10%. If PP chooses to continue to use their single cutoff rate based on the company’s overall WACC, they will now have a cutoff of 11.3%. Again, the problem with using the single rate method is that it does not allow use to see, or account for the differences in each division of PP. Another problem with the single cutoff rate is that due to the increased rate PP will invest their funds in higher return projects which will result in higher risk. This risk is a result of only the high-risk divisions being able to exceed the single rate hurdles using the single rate cutoff method. If PP chooses to go with the multiple cutoff rate approach it allows them to create cutoff rates that reflect the risk-profit characteristics of the individual economic sectors in which PP’s subsidiaries operate. In order to do this you need to determine the equity, debt, and WACC of each firm for each sector as opposed to the single cutoff

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