Pioneer petroleum items for discussion Group#10

Key objectives: calculation of WACC and use of hurdle rates in risk return analysis.

1. Does Pioneer estimate its overall weighted average cost of capital correctly?

a. Evaluate technique, weights and rates.

b. How should they estimate their cost of equity capital?

ANS:

To estimate the overall weighted average cost of capital, Pioneer used the weighted average cost of capital method. First, they find the proportions of each source of capital which is equity and debt.

Because the firm policy had been adopted that funded debt should represent approximately 50% of total capital. So the weight of Debt and Equity are 50% respectively. The weights Pioneer used are correct.
*…show more content…*

Finally, the firm should use the discount rates times each weights, and get the specific rate for each sector.

4. 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 the different standards be determined?

ANS: Different projects should be set according to their risks and expected returns, even though they are in a given division. The various situation and market fluctuation for each project might lead to different returns. So Pioneer should set the cost of capital and weights distinctly among those projects. Because Beta represents the risk of a project and different projects show different risks, Beta used to calculate the CAPM should be determined depending on the risks. In addition, in determination of weights of debt and equity, they should also consider differently because initially Pioneer set half and half. But we believe in the future capital budgets, being more specific when setting the weight instead of just evenly distributed would be more reasonable.

5. Should the discount rate for environmental projects vary by division or be one corporate rate?

ANS: The discount rate for environmental projects should be vary by division. Because environmental project is very special and difficult to predict the return. Sometimes it would show its benefit for the firm in a long

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