De La Salle University

Ramon V. Del Rosario College of Business

Financial Management - FNC535M

PIONEER PETROLEUM COMPANY

A Case Analysis & Corporate Strategy

Individual Report

Member's Name “Role” in the Group College Degree

Ranieses, Jessica Jaye Contributor / Researcher BS Business Management

Dean Atty. Joe-Santos Balagtas Bisquera

MBA Professor

Ranieses, Jessica Jaye Pioneer Petroleum Company 1

Nov. 26, 2016
 TABLE OF CONTENTS
Executive Summary

Problem
Operational
Institutional

Corporate Objective

Areas of Consideration
Environmental Opportunities & Threats
Macro-Economic Indicators
Political
Economic
Demographic
Socio-Cultural
Market Profile & Outlook
Competition
Technology

Business Resources
Corporate Franchise
Shareholders & Key Officers
Marketing Profile
Product
Price
Place & Distribution
Promotion and Advertising
Financial Profile
Profitability
Financial Leverage

Competitive Advantage

Alternative Strategies

Conclusion & Strategic Decision

Grand Design & Execution

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 Executive Summary

Pioneer Petroleum is a company formed in 1924 through the merger

of formerly independent firms operating in the oil refining, pipeline
transportation and industrial chemicals fields. Over the next 60 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
1986 as a hydrocarbons- based company, concentrating on oil, gas, coal
and petrochemicals. The company was one of the producers of Alaskan
crude, and in 1990, Alaska provided 60% of Pioneer domestic liquids
production. 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 the crude oil for its West Coast
refining and marketing operations. This integration required collaboration
and coordination among divisions to optimize overall performance and to
decrease overall risk.

In 1991, one of the critical problems confronting the management and

Board of Directors of Pioneer was the determination of a minimum
acceptable rate of return on new capital investments. The company was
weighing two alternative approaches: (1) a single cutoff rate based on the
company's overall weighted cost of average, and (2) a system of multiple
cut- off rates that reflected the risk- profit characteristics of the several
business or economic sectors in which the company's subsidiaries
operated.

Proponents of the single cut- off rate argues that the stockholders of
Pioneer expected the company to invest their funds in the highest return
projects available and that those proposing a multiple cut- off rate do so
only because they were unable to compete effectively for new funds. On
the other hand, supporters of multiple cut- off rate argues that a single
companywide cost of capital subsidized the higher- risk divisions at the
expense of the lower- risk divisions.

Upon analysis, it is recommended that Pioneer use a multiple cut- off

rate as this will allow the company to more accurately measure the risk and
profitability of each investment.

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Nov. 26, 2016
 Problem

Institutional
How should Pioneer Petroleum Company determine the minimum
acceptable rate of return: through (1) a single cutoff rate based on the
company's overall weighted cost of average, or (2) a system of multiple cut-
off rates?

Operational
Should there be adjustments in the figures Pioneer will use in the
projection for the weighted cost of capital such as the dividend growth rate
which is projected at 10%?

Corporate Objective

Pioneer aims to provide their stockholders the highest return

available from their projects.

Areas of Consideration

Environmental Opportunities & Threats

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Nov. 26, 2016
Macro-Economic Indicators

Political
Between 1990 and 1994 South Africa dismantled apartheid
surprisingly peacefully. With the Oslo Accords, Israel and the
Palestine Liberation Organization had come together at last to
negotiate a framework for coexistence and eventual peace. The civil
wars in the former Yugoslavia ended and an enduring peace was
restored. China became normal, reforming its economy, tripling its
gross domestic product and easing its way into the world order.

Economic
America at large was prospering in the '90s. The United States
economy grew by an average of 4 percent per year between 1992
and 1999. (Since 2001, it's never grown by as much as 4 percent,
and since 2005 not even by 3 percent for a whole year.) An average
of 1.7 million jobs a year were added to the American work force,
versus around 850,000 a year during this century so far. The
unemployment rate dropped from nearly 8 percent in 1992 to 4
percent – that is, effectively zero – at the end of the decade. Plus, if
you were a man and worked in an office, starting in the '90s you could
get away with never wearing a necktie.

sAndersen, K. (2015). The Best Decade Ever? The

1990s, Obviously. New York Times.
.
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Nov. 26, 2016
 Demographic
Technology also had a major impact on Popular 1990s Toys with
computer gaming systems and the games available increasing in
price with vastly improved graphics and gaming capabilities. Plus
talking dolls, bears and other similar toys caused queues over the
peak Christmas Period with parents searching for available stoc k

Socio-Cultural
Peace, prosperity, order – and American culture was vibrant and
healthy as well. There were both shockingly excellent versions of
what had come before and distinctly new, original forms. Wasn't the
release of Nirvana's “Nevermind,” in 1991, pretty much the last time a
new rock 'n' roll band truly, deeply mattered, the way rock 'n' roll did in
the '60s and '70s? Wasn't hip-hop, which achieved its mass-market
breakthrough and dominance in the '90s, the last genuinely new and
consequential invention of American pop culture?

Market Profile & Outlook

In 1990, Pioneer spent about $3.1 billion on capital expenditures and
forecasted capital expenditures of almost $4.5 billion in 1991. Some of
these expenditures include the addition of a sulfur recovery facility and the
improvement of a coker that allowed the refineries to more efficiently
process the heavy Alaskan crude oil. These investments had provided
good returns and the light product yield in Pioneer's refineries was
substantially higher than the industry average. Pioneer also invested into
environmental projects that allowed them to produce gasolines that were
among the cleanest- burning in the world. Pioneer's chemical unit produced
about one- third of the world's supply of methyl tertiary ether (MTBE), which
was used to make clean- burning gasolines. The market for MTBE had
been growing and the new regulations were expected to lead to even
higher growth.

kThe People History

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Competition

Details of competition were not specified in the case.

Technology
Pioneer was able to invest in facilities and machineries that allowed
them to produce not just efficiently- processed crude oil but as well as
clean- burning gasolines. Investments were also directed into environment-
friendly projects that allowed compliance to government regulations.

Business Resources

Corporate Franchise
The company was one of the producers of Alaskan crude, and in
1990, Alaska provided 60% of Pioneer domestic liquids production. 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 the crude oil for its West Coast refining and
marketing operations.

Shareholders & Key Officers

This was not specified in the case except for the company's
investment bankers, Steven, Mitchell and O'Hara.

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Marketing Profile

Product

Some of Pioneer's products include Crude oil, gas, coal and

petrochemicals.

Price

Pioneer was also one of the lowest- cost refiners on the West Coast.

Place & Distribution

Details were not explicitly mentioned in the case except on

information on crude oil distribution in Alaska and to West Coast states.

Promotion and Advertising

Details about the company's promotion and advertising were not

mentioned.

Financial Profile

Profitability
In 1990 total revenues exceeded $15.6 billion and net income was
over $1.5billion.

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 Financial Leverage

The company was committed to using its dividend and stock

repurchase program to maintain appropriate financial leverage. Cash
dividends increased by 10% in both 1990 and 1991. Its debt was A-
rated. Investment bankers also forecasted that in early 1990, the
company's future debt issues would require a coupon of 12%,
assuming continuation of its debt policy and A- rating.

Competitive Advantage
Environmental regulations provided the opportunity for Pioneer to
capitalize on its strengths. Pioneer's gasolines were among the cleanest-
burning in the industry.

Alternative Strategies

Alternative 1: Use a single cut- off rate based on company's overall

WACC

The company's weighted average cost of capital is calculated in

three- steps: first, the expected proportions of future funds sources were
estimated; second, costs were assigned to each of these sources; third, a
weighted average cost of capital was calculated on the basis of these
proportions and costs.

Estimated Historical (Actuals) Projections

Proportions of
Source
Future Funds
Sources
1990 1991 1992
Esitimated Weighted Esitimated Weighted Esitimated Weighted
Future After- cost Future After- cost Future After- cost
tax cost tax cost tax cost
Debt 0.5 7.9% 4.0% 7.9% 3.96% 7.92% 3.96%
Equity 0.5 10.0% 5.0% 14.3% 7.14% 9.85% 4.92%
WACC 9% 11.10% 8.88%

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 From the manner by which WACC is calculated by Pioneer, it follows
that cost of equity calculation should include projected dividends for 1991.
As stated by management, dividend growth assumption is set at 10% with
a stock price of $63 and a $2.70 dividend per share projection for 1991. As
such cost of equity is 14.28 %. Further calculation will give us WACC of
11.10% for 1991. For 1992, however, dividend growth rate is assumed to
be lower based on the average of recent years' data. This is to account for
the data that Pioneer's dividend is not always at 10% such as in years 1986
and 1989 where there was no growth and in 1986 where dividend per
share grew up to 66.66%.

Share Percent
Year change
Actuals 1986 $2.00 -
1987 $2.00 0%
1988 $2.00 0%
1989 $2.20 10%
1990 $2.45 11.36%
Average 5.34%

Should Pioneer use a single companywide WACC, average would be 9.7%

ADVANTAGES DISADVANTAGES

This will foster competition among A single company- wide cost of

the divisions for funding capital subsidized the higher-
risk divisions at the expense of
the lower- risk divisions

Alternative 2: Use multiple cutoff rates in determining the cost of

capital for each division

The divisional cost of capital would be calculated using a weighted

average cost of capital approach for each operating sector. The

%Cost of equity = dividend projection/stock price +

dividend growth assumption

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calculations would follow three steps: first, an estimate would be made of
the usual debt and equity proportions of independently financed firms
operating in each sector. Second, cost of debt and equity given these
proportions and sectors would be estimated in accordance with the
concepts followed by the company in estimating its own cost of capital.
Third, these costs and proportions would be combined to determine the
WACC.

Using this approach would mean that Pioneer must determine the
cost of capital of each division using models used in computing such as
CAPM. This would allow Pioneer to measure the risk and expected returns
as well as diversify their portfolio that will eventually lead to increase in
profits.

For each of the subsidiary of Pioneer, its own WACC would serve as
the minimum required return on in investment. Risks involved in each
subsidiary would be indicated by the variance in cost of equity once
individual WACC is computed. From this, Pioneer will be able to identify the
level of risk involved in the different subsidiaries thus giving the company
assurance that each market segment is able to go ahead of competition.

ADVANTAGES DISADVANTAGES

Subsidizing higher- risk divisions Could lead to lessened

at the expense of the lower- aggressiveness of each
risk divisions would be avoided division in competing for
funding

Conclusion & Strategic Decision

Comparing the two alternatives, it is recommended that Pioneer use

multiple cutoff rates. This provides a more accurate assessment rather than
a standard cost of capital set by a single companywide WACC. Using
multiple cut-off rates can help Pioneer in avoiding potentially bad
investments that a single companywide WACC presents.

Grand Design & Execution

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Nov. 26, 2016
 In accepting or rejecting projects, the profitability and risk of an
investment must be compared to each divisional WACC. Cost of capital
must be determined for each division that will allow Pioneer to accurately
measure the risks and expected net returns of each investment.

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Nov. 26, 2016