Pioneer Petroleum Corporation

Pioneer Petroleum Corporation

One of the critical problems confronting management and the board of Pioneer Petroleum Corporation was the determination of a minimum acceptable rate of return on new capital investments, The company’s basic capital budgeting approach was to accept all proposed investments with a positive net present value when discounted at the appropriate cost of capital. At issue was how the appropriate discount rate would be determined.

The company was weighing two alternative approaches for determining a minimum rate of return: (1) a single cutoff rate based on the company’s overall weighted average cost of capital, and (2) a system of multiple cutoff rates that reflected the risk-profit characteristics of the several business or economic sectors in which the company’s subsidiaries operated. The issue had assumed increased importance because of management’s decision to extend the use of the cutoff rate to the evaluation of existing operations and investments. It was planned to evaluate divisional managers on the basis of their net profits after the deduction of a charge for capital employed by the division.

Pioneer Petroleum had been formed in 1924 through the merger of several formerly independent firms operating in the oil refining, pipeline transportation, and industrial chemical fields. Over the next 80 years, the company integrated vertically into exploration and production of crude oil and marketing refined petroleum products, and horizontally into plastics, agricultural chemicals, and real estate development. It was restructured in 1985 as a hydrocarbons-based company, concentrating on oil, gas, coal, and petrochemicals. Pioneer was one of the primary producers of Alaskan crude. Pioneer was also one of the lowest-cost refiners on the West Coast and had an extensive West Coast marketing network. Pioneer's Alaskan crude production provided all of the crude oil for its West Coast refining and marketing operations. This integration required...