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"Gibson Appliance Co. is a very stable billion dollar company with a sales growth of about 7 percent per year in good or bad economic conditions....

"Gibson Appliance Co. is a very stable billion dollar company with a sales growth of about 7 percent per year in good or bad economic conditions. Becasue of this stability (a coefficient of correlation with the economy of +4 an a standard deviation of sales of about 5 percent from the mean), Mr. Hoover, the vice president of finance, thinks the company could absorb a small risky company that could add quite a bit of return without increasing the company's risk very much. He is trying to decide which of the two companies he will uy, usig the figures below. Gibson's cost of capital is 12%.

Genetic Technology
(cost 80 million)
Cash Flow for 10 yrs
(in millions) Probablility
$2 .2
8 .3
16 .2
25 .2
40 .1

Silicon Microchip Co
Cash Flow for 10 yrs
(in Millions) Probability
$5 .2
7 .2
18 .3
24 .3

c. Compute the net present value of each company
d. Which company would you pick, based on net present value?
e. Would you change your mind if you added the risk dimensions to the problem? Explain.
f. Whatif Genetic Technology had a coefficient of correlation with the economy of a -.2 and Silicon had one of +.5? Which of these companies would give you the best portfolio effects for risk reduction?
g. What might be the effect of the acquisitions on the market value of Gibson Appliance Co.'s stock?"

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