Treynor Pie Co. is a food company specializing in high-calorie snack foods. It i

ID: 2612346 • Letter: T

Question

Treynor Pie Co. is a food company specializing in high-calorie snack foods. It is seeking to diversify its food business and lower its risks. It is examining three companies—a gourmet restaurant chain, a baby food company and a nutritional products firm. Each of these companies can be bought at the same multiple of earnings. The following represents information about all the companies.

Company

Correlation with Treynor Pie Company

Sales ($ millions)

Expected Earnings ($ millions)

Standard Deviation in Earnings ($ millions)

Treynor Pie Company.....

+ 1.0

$126

$10

$4.0

Gourmet restaurant.........

+ .4

1.4

Baby food company........

+ .3

1.6

Nutritional products

company..........................

3.2

Using the last two columns, compute the coefficient of variation for each of the four companies. Which company is the least risky? Which company is the most risky?

Discuss which of the acquisition candidates is most likely to reduce Treynor Pie Company’s risk? Explain why.

Company

Correlation with Treynor Pie Company

Sales ($ millions)

Expected Earnings ($ millions)

Standard Deviation in Earnings ($ millions)

Treynor Pie Company.....

+ 1.0

$126

$10

$4.0

Gourmet restaurant.........

+ .4

1.4

Baby food company........

+ .3

1.6

Nutritional products

company..........................

3.2

Explanation / Answer

Solution-a

Coefficient of variation (V) = Standard Deviation / Expected Value

(In Millions)

Treynor Pie Co.

$4.0 / $10

$0.4

Gourmet Restaurant

$1.4 / $9

$0.16

Baby Food

$1.6 / $5

$0.029

Nutritional Products

$3.2 / $7

$0.45

The nutritional products firm has the highest risk with a coefficient of variation of 0.45, while Gourmet Restaurant chain is the least risky with a coefficient of variation of 0.16.

Solution-b

The nutritional products firm is very high negative highly correlated which is -.7 with the Treynor Pie Company, It is likely to reduce the risk. It shows that demand of the high calorie snacks food move opposite of the demand related to nutritional products.

So, Treynor Pie Company will reduce the risk by acquiring the co. with the high coefficient of variation 0.45 as compute in solution-a. This shows that the interaction of the two companies is more important than the individual risk of both the companies.