Submitted by: Submitted by naotoyoshida
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Category: Business and Industry
Date Submitted: 01/31/2012 03:25 PM
Case 3: Pioneer Petroleum Corporation
THE PROBLEM
- The determination of a minimum acceptable rate of return on new capital investments
The critical problems confronting
Management
The board of Pioneer Petroleum Corporation in July 1991
- Basic capital budgeting approach
Accept all proposed investments with a positive NPV
Discounted at the appropriate cost of capital
- How the appropriate discount rate would be determined?
- Two alternative approach for determining a minimum rate of return
A single cutoff rate
Based on the company’s overall WACC
A system of multiple cutoff rates
Reflected the risk-profit characteristics - the company’s subsidiaries
Business
Economics sectors
- Management’s decision to extend the use of the cutoff rate to the evaluation of existing operations and investments
Planned to evaluate divisional managers on the basis o their net profits
After the deduction of a charge for capital employed by the division
BACK GROUND OF THE CASE
- Pioneer Petroleum
Formed in 1924
The merger of several formerly independent firms
Over the next 60 years
Integrated vertically into exploration and production of crude oil
Marketing refined petroleum products
Horizontally into plastics…
Restructured in 1985
A hydrocarbons-based company
Primary producers of Alaskan crude oil
1990 – Alaska provided 60% of domestic petroleum liquids production
One of the lowest-cost refiners on the West Coast
- Integration – among divisions
Collaboration
Coordination
to optimize overall performance
to decrease overall risk
- Financial Statement (1990)
Total revenues – over 15.6 billion
Net income – over 1.5 billion
- Volatile oil prices – a major concern for pioneer
24.50 per barrel on average
Management of Pioneer
The importance of operational and financial flexibility to respond to price swings
- Capital expenditures
3.1 billion (1990)
4.5 billion (1991...