Case Analysis on Capital Structure Pioneer Petroleum Essay

4500 Words Feb 23rd, 2013 18 Pages
Application of Capital Structure, Costs of Capital for Multiple Division firms

Case Analysis: Pioneer Petroleum Corporation (PPC).1

Submitted by: Joseph Donato N. Pangilinan, FICD
Date Presented: April 12, 2012

Introduction:

This landmark case seeks to break the risk-reward trade off involved in calculating Capital Cost. The object of the solution must be to minimize project risks while maximizing project opportunities available. We want a rate and a rating system that does not unnecessarily reject “the best available projects – i.e. highest net positive free cash-flows at that time.” Particularly in times of excess capacity, this will marginally contribute to increasing company wide yields, but will not necessarily match
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Weaknesses and Threats:

To meet Pioneer expected to invest $3 Billion additional to meet the new law’s standards among other new environmental regulations. Its multinational status makes it vulnerable to foreign currency exchange risks, political risks, interest rate volatility, cultural risks, and transfer pricing and other transnational risks involving a complex network of sources, sinks and of moneys, products and services.

Its fully integrated set-up requires spreads itself quite thinly, and requires seamless transnational collaboration and cross-border coordination to work. Management wanted synergy among global divisions to optimize overall performance, and obviously to decrease these complex risks.

Methodology:

The weighted cost of capital approach is applied, first apportioned pro rata based the usual cost of the fund source: i.e. debt and/or equity. The cost of debt would be prevailing interest rates, and the cost of equity would be “foregone” earnings on capital invested as equity – i.e. earnings per share over market value per share.

The second approach is similar, but with multiple cutoff rates. First it is broken down by Divisional Cost of Capital – i.e. calculated using a weighted average cost of capital approach, but this time for each division or operating sector; before further drilling down by cost per fund source. Calculations would follow three (3) steps: a) First an estimate would be made of the usual

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