Inserting capital criteria within a given division of pioneer petroleum corporation acceptable criteria for all projects should be set to avoid problem of agency. A multiple cut of rate for the project should not be an issue since with the help of the computer simulation will be carried out and acceptable single cut of rate will be available for use. This does not necessarily be the overall weighted average cost of capital but a simulated rate. Agency problem arises when a multiple project rates are used to evaluate projects since managers may put a project in a certain level of risk and this may not be true.
Therefore, it is necessary for the management to be able to have a means of analyzing risk to translate into a single rate rather than a multiple rate. The rate that will be used will be the rate which is risk adjusted giving a good return. For pioneer to be able to have a uniform rate of return that uses a risk adjusted rate they must be able to assign probabilities to various projects then sensitivity analysis is carried out. There are two main approaches towards distinguishing the riskiness of projects. Requiring a higher return for the projects or shortening pay back for riskier project.
The company should first use the weighted average cost of capital in making decision of the best method to be used. The distinction in projects that should be captured in coming up with the criteria for evaluating this project should be type of investment that is ; an investment in international market has different risk as compare to investment internally. International investment has political risks exchange rate risk, which are very crucial in the success of the investment. While local projects has economical and political risk to considered.
The amount of capital required also is another factor included in the criteria. Lastly, agency problem should be considered before making any decision. In a nutshell there are four risks that affect businesses that is exchange rate risks transaction risk economic risk and translation risk. The standard to be used for this project should be through the form of simulation where a more accurate answer will be available to use by the firm. References Ghetti A. (2008); Terrific introduction to financial management; Amazon Higinns R. C. (2000); Analysis of financial management; Irwin/McGraw