The Cost Of Capital Budget

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The risk that the company puts itself in within their sector should also give an idea of the capital budget. A higher risk within a specific sector the more that there should be invested. The cause of this was a hurdle rate that was too low. Another point to address is the projects overall contribution to the firms borrowing power. What may occur is the cost of debt ratio to fluctuate with the cost of equity ratio. As the company continues to operate, the process needs to carefully dissect each sector specifically, not the company as a whole. The risk will also be taken account by the age of the specific project. There are times that a project will have a higher risk when at a younger age and some that may not be. Vice versa for the…show more content…
Therefore the discount rate should capture the future risks of the investment. If each of the sector that Pioneer works with needs a different discount rate how would that look? The first thing to look at would be the divisional rate that would translate the risks in each sector or industries in which the company’s principle operating subsidiaries worked. This would also help to establish a better benchmark with the sector. To get the divisional cost of capital would be to use a specific WACC for each sector. There would need to be an estimate made of the debt and equity proportions of the independently financed firms in each sector. The costs of debt and equity given these sectors would be figured by the concepts followed by a company in estimating its own cost capital. The proportions and costs would certainly be combined to determine the WACC, minimum rate of return for NPV discounting purposes in each of the sectors that Pioneer is working with. Another issue that stuck out to me is that PCC previously calculated different hurdle rates per division but the weighted average was higher than the real hurdle rate for the whole company. The reason why there was a difference was the divisional cost of capital overlooked the risk diversification benefits of many of the investments that Pioneer was in. For instance, the risk for PPC for a refinery investment is much lower than an independent company that doesn’t have
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