Pioneer Petroleum Corporation

Pioneer Petroleum Corporation's (PPC) has been through a diverse amount of changes throughout the years. They were originally were a merger of several different independent firms operating in the oil refining, pipeline transportation, and industrial chemicals fields. PPC then integrated vertically into exploration and production of crude oil and marketing refined petroleum products, but horizontally into plastics, agricultural chemicals, and real estate development. They decided to restructure the company into a hydrocarbons-based company, concentrating on oil, gas, coal, and petrochemicals. They needed to decrease their overall risk and optimize their overall performance and would only be able to by collaboration and coordination among their refining and marketing network divisions.

PPC were spending billions of dollars on capital expenditures and were expecting an increase in the next year. These expenditures were allowing for the company to process heavy Alaskan crude oil more efficiently and also provided good returns. In the next five years, the company was going to need to meet new environmental standards, which meant more spending increases. Along with these expenditures and regulations were expected higher growths because now the company truly could utilize and capitalize on their strength.

PPC's management and board are weighing out two alternative approaches in order to determine a minimum rate of return. They had to decide if a single cutoff rate based on the company's overall weighted average cost of capital (WACC) or a system of multiple cutoff rates that reflected the risk-profit characteristics of the several businesses or economic sectors in which the company's subsidiaries operated would be the better alternative. Their basic capital budgeting approach was to accept all proposed investments with a positive net present value (NPV) when discounted at the appropriate cost of capital. If Pioneer wanted to compete and remain active in the industries they were currently in, a decision was needed.

Pioneer believes to estimate their corporate weighted average cost of capital at 9%. With the economy and the market constantly fluctuating, the actual rate of return fluctuates with the market. The discounted rate gives a weighted average cost of capital (WACC) of 9% (Example 1). The divisions will ultimately affect the company and the WACC will fluctuate along with the divisional costs of capital. The risks involved within the divisions are reflected in the risks that the company overall chooses to invest.

Example 1

WACC = rdebt(1-Tc)(D/V)+requity(E/V)

=.12(1-.34).50+.10*.50 = .0896 = 9%

The company has invested into many different industries and markets. Each industry's risk is different and remaining diversified is crucial to obtaining a marginal rate of return.