PROBLEM ha sales growth of use of this stability deviation of sales finance, thinks the bit of return without ch of the two companies pliance Co. Gibson Appliance Co. is a very stable billion-dollar company with a sales fect of a about 7 percent per year in good or bad economic conditions. Because of this (a coefficient of correlation with the economy of +0.4, and a standard deviation of about 5 percent from the mean), Mr. Hoover, the vice president of finance. th company could absorb a small risky company that could add quite a bit of retur increasing the company's risk much. He is trying to decide which of the two cl he will buy, using the following figures. Gibson's cost of capital is 12 percent Genetic Technology Co. Silicon Microchip Co. (cost $80 million) (cost $80 million) Cash Flow Cash Flow for 10 Years for 10 Years ($ millions) Probability ($ millions) Probability $ 2 0.2 $5 0.3 7 0.2 16 18 0.2 0.3 40 0.1 0.2 8 0.2 0.3 24 a. What is the expected cash flow from both companies?! b. Which company has the lower coefficient of variation? C. Compute the net present value of each company. d. Which company would you pick, based on the net present values? e. Would you change your mind if you added the risk dimensions to the problem? Explain. Chapter 13 Risk and Capital Budgeting f. What if Genetic Technology Co. had a coefficient of correlation with the economy of -0.2 and Silicon Microchip Co. had one of +0.5? Which of these companies would give you the best portfolio effects for risk reduction? 8. What might be the effect of the acquisitions on the market value of Gibson Appliance Co.'s stock