Pioneer Petroleum

Pioneer Petroleum Analysis

1) How does Pioneer calculate its hurdle rate at the moment?

At the moment Pioneer Petroleum uses the overall Weighted Average Cost of Capital to calculate its hurdle rate. Weighted average cost of capital of Pioneer was calculated in 3 steps:

I. The expected proportions of future funds sources were estimated.

II. Costs were assigned to each of these sources.

III. A weighted average cost of capital was calculated on the basis of these proportions and costs.

2) How does Pioneer estimate the cost of equity? Does it seem reasonable to you?

a. Suppose the company has a bad year. What will be the effect of this on the cost of equity?

Pioneer uses the current earnings yield on stock as the cost of both new equity and retained earnings.

The Earnings Yield Definition is given as:

Earnings Yield: The earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (which is the inverse of the P/E ratio) shows the percentage of each dollar invested in the stock that was earned by the company.

Hence Earnings yield represents the forecast earnings divided by the market price.

Does it seem reasonable to you?

If earnings yield is used for cost of equity then it will change a lot because the price of the stock fluctuates every day. So earnings yield is not reliable enough to provide an accurate measure of

Cost of equity.

Moreover, a single company-wide cost of capital subsidizes the higher risk divisions at the expense of the lower risk divisions.

Effect of bad year on cost of equity:

If the company has had a bad year, then it will reflect on the stock price. The stock price of the company will come down. Since the company had already made the forecast earnings on each share the previous year, the earnings yield or E/P ratio will become higher. Consequently the cost of equity for Pioneer will become high.

Also in simple terms it means that...