Treynor Pie Company is a food company specializing in high-calorie snack foods.
ID: 2724023 • Letter: T
Question
Treynor Pie Company 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.
Compute the coefficient of variation for each of the four companies. (Enter your answers in millions (e.g., $100,000 should be entered as ".10"). Round your answers to 3 decimal places.)
Treynor Pie
Company Sales
($ millions) Expected Earnings
($ millions) Standard Deviation
in Earnings
($ millions) Treynor Pie Company + 1.0 $ 178 $ 9 $ 3.0 Gourmet restaurant + .5 63 9 1.2 Baby food company + .4 51 5 1.8 Nutritional products company .8 74 6 3.1
Explanation / Answer
a.) Coefficient of variation (V) = Standard deviation / Expected Value
Treynor Pie Co. $ 3 / 9 = 0.3333
Gourmet Restaurant 1.2 / 9 = 0.1333
Baby Food 1.8 / 5 = 0.36
Nutritional Products 3.1 / 6 = 0.5167
The Gourmet Restaurant would be the least risky based on the coefficient of variation being 0.1333. The Nutritional Products would be the most risky based on the coefficient of variation being 0.5167
b.) The Nutritional Products Company is most likely to reduce Treynor Pie Company’s risk even though its correlation is negative. A negative correlation on a new project has the most favorable effect on smoothing business cycle fluctuations. The demand for high calorie snack foods is in the opposite direction of the demand for nutritional items. Treynor Pie Company reduces its risk by the largest extent by choosing a company with the highest coefficient of variation. The interaction between the two companies is more important than the individual risk.
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