Pioneer - Determine a Minimum Acceptable Rate of ReTurn On New Capital Investments

Pioneer

Problem: determine a minimum acceptable rate of return on new capital investments

Capital budgeting approach: accept all proposed investments with a positive net present value when discounted at the appropriate cost of capital. 接受所有NPV为正的项目

At issue: how the appropriate discount rate would be determined. 决定最小贴现率/报酬率

Other approaches to determine a minimum rate of return:

1. a single cutoff rate based on the company’s overall weighed average cost of capital

2. 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.

Pioneer:

 Formed in 1924 with the merger of firms operating in the oil refining, pipeline transportation, and industrial chemical fields.

 1924-1984, integrated vertically into exploration and production of crude oil and marketing refined petroleum products and horizontally into plastics, agricultural chemicals, and real-estate development.

 1985, restructured as a hydrocarbons-based company, concentrating on oil, gas, coal and petrochemicals.

One of the primary producers of Alaskan crude; in 1990 Alaska provided 60%of Pioneer’s production. One of the lowest cost refiners on the West Coast and has an extensive West Coast marketing network. (Pioneer’s Alaskan crude production)

Volatile oil prices:

1990, Q1 21.8; mid-June 15.5; with the invasion, more than 40, fell to 25 at the end of the year. Average 24.5/barrel. The management of Pioneer emphasized the importance of operational and financial flexibility to respond to these price swings.

Capital expenditures:

 Allow the refineries to more efficiently process (good returns higher than the industry average)

 Exploration and development

 Environmental projects ($3 billion in the next 5 years); MTBE/SMOGMAN

WACC: debt 7.9%; equity 10%; prop:50%. WACC=9%

Debt:50%

Cash dividends increased by 10% in both 1990,1991

Debt coupon 12%, tax 34%, after debt is 7.9%

Equity: current earnings yield on the stock as the cost of both new equity and retained earnings. No dilution. 6.15/63

Divisional costs of capital

The divisional rate would