Questions for Pioneer Corporation
Group Members: Arun Prakash Muralidhar Babu (Section 2); Anindita Pal (Section 6) and Raghav Sharma (Section 5)

Please comment critically on the following:

1- Do you agree with the way the company computes its weighted average cost of capital. Why or why not? Be specific? How would you compute the WACC? Use RF= 8.08%, Beta of equity for Pioneer = 0.8 and RM-RF = 7%
I disagree with the way the company computes it’s WACC.
They are assuming a cost of equity based on the current earnings yield on the stock to raise new equity. This does not make sense as the share price can fluctuate and vary based on multiple market factors. Also the market risk premium to raise new capital is not factored in here. So we should use the Capital Asset Pricing Model to calculate cost of equity.

Cost of equity = Rf + Beta * Market Risk Premium = 8.08% + 0.8* 7% = 13.68%

Since the company has instituted a policy to maintain a 50-50 equity-debt, % of debt and % equity = 0.5

Since the company has policies to maintain appropriate financial leverage, its fair to assume they will sustain their A rating. Therefore, Tax deducted cost of debt is 7.9%.
WACC is given by: 0.5* 13.68% + 0.5*7.9% = 10.79% 2- Should Pioneer use a single cutoff versus multiple cutoffs for discount rates if beta of exploration division is 1.07, beta of refining division is 0.95, and beta of transportation division is 0.52? Why?

I think that Pioneer should evaluate each division with its own beta and calculate a separate hurdle rate for investments in the respective divisions. i.e WACC for exploration = 0.5 * 7.9% + 0.5 * (8.08% + 1.07*7%) = 11.7% WACC for refining = 0.5 * 7.9% + 0.5 * (8.08% + 0.95*7%) = 11.3% WACC for transportation = 0.5 * 7.9% + 0.5 * (8.08% + 0.52*7%) = 9.8% If we use a common hurdle rate