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Pioneer J.J. van den Berg - Pioneer Petroleum Homework...

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Pioneer Petroleum Homework Corporate Finance TiasNimbas Business School PTMBA-6 November 2009 Drs. J.J. (Jacob) van den Berg Question 1 I disagree with the calculation of the WACC, as presented in the case. It is better to use market value weights when calculating the WACC. In the case, since 1980 the average return on the S&P Index of common stocks was 16.25%, which substantially exceeded the 9% company wide cost of capital. It is also better to define the cost of equity according to the Capital Asset Pricing Model (CAPM). There are three input variables for the CAPM: 1) the risk free rate of return; 2) the firm’s beta coefficient; 3) the equity market risk premium. In the case the cost of equity is calculated as follows: Pioneer uses the current earnings yield on the stock as the cost of both new equity and retained earnings. This way of dividing the market price by the earnings per share is too simplified. The CAPM version of the cost of equity is: Ke = Rf + β*(R ~ i – R ~ f) where, Rf = risk-free rate of return (T-bill rate 1990, exhibit 2) β = beta coefficient of the firm’s stock (exhibit 2) R ~ i = mean return 1980 – 1990 (given in the text, page 4) R ~ f
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