8. Under what circumstances might the validity of comparative ratio analysis be questionable? Answer this question in general, not just for Mark X, but use Mark X data to illustrate your points.

TABLE 1 Historical and Pro Forma Balance Sheets for Years Ended December 31(in Thousands of Dollars) Proforma 1990 1991 1992 1993 1994 Assets: Cash and marketablesecurities $ 5,149 $ 4,004 $ 3,906 X X Accounts receivable 17,098 18,462 29,357 X X Inventory 18,934 33,029 46,659 X X Current assets $41,181 $55,495 $79,922 X X Land, buildings, plant, and equipment $17,761 $20,100 $22,874 $29,249 30,126 Accumulated depreciation (2,996) (4,654) (6,694) (9,117) (10,940) Net fixed assets $14,765 $15,446 $16,180 $20,132 $19,186 Total assets $55,946 $70,941 $96,102 X X Liabilities and Equity: Short-term bank loans $3,188 $ 5,100 $18,233 X X Accounts payable 6,764 10,506 19,998 15,995 16,795 Accruals 3,443 5,100 7,331 9,301 11,626 Current liabilities $13,395 $20,706 $45,562 X X Long-term bank loans $ 6,375 $ 9,563 $ 9,563 $ 9,563 $ 9,563 Mortgage 2,869 2,601 2,340 2,104 1,894 Long-term debt $ 9,244 $12,164 $11,903 $11,667 $11,457 Total liabilities $22,639 $32,870 $57,465 X X Common stock $23,269 $23,269 $23,269 $23,269 $23,269 Retained earnings 10,038 14,802 15,368 X X Total equity $33,307 $38,071 $38,637 X X Total liabilities and equity $55,946 $70,941 $96,102 X X Notes: a. 3,500,000 shares of common stock were outstanding throughout the period 1990 through 1992. b. Market price of shares: 1990$17.78; 1991$9.71; 1992$3.67. c. Price/earnings (P/E) ratios: 19906.61; 19915.35; 199217.0. The 1992 P/E ratio is high because of the depressed earnings that year. d. Assume that all changes in interest-bearing loans and gross fixed assets occur at the start of the relevant years. e. The mortgage loan is secured by a first-mortgage bond on land and buildings.

Case: 35 Financial Analysis and Forecasting TABLE 2 Historical and Pro Forma Income Statements for Years Ended December 31 (Thousands of Dollars) Pro Forma 1990 1991 1992 1993 1994 Net sales $170,998 $184,658 $195,732 X X Cost of goods sold 187,684 151,761 166,837 X X Gross profit $ 33,314 $ 32,897 $ 28,895 $37,678 $49,520 Administration and selling expenses $ 12,790 $ 15,345 $ 16,881 $17,224 X Depreciation 1,594 1,658 2,040 2,423 1,823 Miscellaneous expenses 2,027 3,557 5,725 3,768 X Total operating expenses $ 16,411 $ 20,560 $ 24,646 X X EBIT $ 16,903 $ 12,337 $ 4,249 $14,263 X Interest on short-term loans $ 319 $ 561 $ 1,823 $ 2,953 $ 2,953 Interest on long-term loans 638 956 956 X 956 Interest on mortgage 258 234 211 X 170 Total interest $ 1,215 $ 1,751 $ 2,990 $ 4,098 $ 4,079 Before-tax earnings $ 15,688 $ 10,586 $ 1,259 X $21,953 Taxes 6,275 4,234 504 4,066 8,781 Net income $ 9,413 $ 6,352 $ 755 X X Dividends on stock 2,353 1,588 89 $ 0 X Additions to retained earnings $ 7,060 $ 4,764 $ 567 X X

Notes: a. Earnings per share (EPS): 1990$2.69; 1991$1.81; 1992$0.22. b. Interest rates on borrowed funds: Short-term loan: 199010%; 199111%; 199210%. Long-term loan: 10% for each year. Mortgage: 9% for each year. c. For purposes of this case, assume that expenses other than depreciation and interest are totally variable with sales. Case: 35 Financial Analysis and Forecasting

TABLE 3 Common Size Balance Sheets for Years Ended December 31 1990 1991 1992 Assets: Cash and marketable securities 9.20% 5.64% 4.06% Accounts receivable 30.56 26.02 X Inventory 33.84 46.56 48.55% Current assets 73.61% 78.23% X Land, buildings, plant, and equipment 31.75% 28.33% X Accumulated depreciation (5.36) (6.56) (6.97) Net fixed assets 26.39% 21.77% 16.84% Total assets 100.00% 100.00% 100.00% Liabilities and Equities: Short-term bank loans 5.70% 7.19% 18.97% Accounts payable 12.09 14.81 20.81 Accruals 6.15 7.19 7.63 Current liabilities 23.94% 29.19% 47.41% Long-term bank loans 11.39% 13.48% X Mortgage 5.13 3.67 2.43 Long-term debt 16.52% 17.15% X Total liabilities 40.47% 46.33% 59.80% Common stock 41.59% 32.80% 24.21% Retained earnings 17.94 20.86 X Total equity 59.53% 53.67% X Total liabilities and equity 100.00% 100.00% 100.00% Note: Rounding differences occur in this table. Case: 35 Financial Analysis and Forecasting

TABLE 4 Common-Size Income Statements for Years Ended December 31 1990 1991 1992 Net sales 100.00% 100.00% 100.00% Cost of goods sold 80.52 82.18 X Gross profit 19.48% 17.82% X Administrative and selling expenses 7.48% 8.31% 8.62% Depreciation 0.93 0.90 X Miscellaneous expenses 1.19 1.93 2.92 Total operating expenses 9.60% 11.13% X EBIT 9.88% 6.68% 2.17% Interest on short-term loans 0.19% 0.30% X Interest on long-term loans 0.37 0.52 X Interest on mortgage 0.15 0.13 0.11 Total interest 0.71% 0.95% 1.53% Before-tax earnings 9.17% 5.73% 0.64% Taxes 3.67 2.29 X Net income 5.50% 3.44% 0.39% Dividends on stock 1.38% 0.86% 0.10% Additions to retained earnings 4.13% 2.58% 0.29% Case: 35 Financial Analysis and Forecasting

TABLE 5 Statement of Cash Flows for Years Ended December 31 (in Thousands of Dollars) 1991 1992 Cash Flow from Operations: Sales $ 184,658 $195,732 Increase in receivables (1,364) X Cash sales $ 183,294 X Cost of goods sold (151,761) (166,837) Increase in inventories (14,095) (13,630) Increase in accounts payable 3,742 9,492 Increase in accruals 1,657 X Cash cost of goods ($160,457) X Cash margin $ 22,837 X Administrative and selling expenses (15,345) ($ 16,881) Miscellaneous expenses (3,557) (5,725) Taxes (4,234) (504) Net cash flow from operations ($ 299) X Cash Flow from Fixed Asset Investment: Investment in fixed assets ($ 2,339 ) ($ 2,774) Cash Flow from Financing Activities: Increase in short-term debt $ 1,912 $ 13,133 Increase in long-term debt 3,188 X Repayment of mortgage (268) (261) Interest expense (1,751) (2,990) Common dividends (1,588) (189) Net cash flow from financing activities $ 1,493 $ 9,693 Increase (decrease) in cash and marketable securities ($ 1,145) X

Case: 35 Financial Analysis and Forecasting TABLE 6 Historical and Pro Forma Ratio Analysis for Years Ended December 31 Pro Forma Industry 1990 1991 1992 1993 1994 Average Liquidity Ratios: Current ratio 3.07 2.68 X X X 2.50 Quick ratio 1.66 1.08 0.73 1.10 X 1.00 Debt Management Ratios: Debt ratio 40.47% 46.33% X X 52.69% 50.00% TIE coverage 13.91 7.05 1.42 X 6.38 7.70 Asset Management Ratios: Inventory turnover (cost)a 7.27 4.59 3.58 5.70 5.70 5.70 Inventory turnover (sales)b 9.03 5.59 4.19 X X 7.00 Fixed asset turnover 11.58 11.96 12.10 10.69 12.91 12.00 Total asset turnover 3.06 2.60 X 2.03 X 3.00 Days sales outstanding (ACP)c 36.00 35.99 53.99 X 32.00 32.00 Profitability Ratios: Profit margin 5.50% 3.44% 0.39% X X 2.90% Gross profit margin 19.48% 17.82% 14.76% 17.50% 20.00% 18.00% Return on total assets 16.82% 8.95% X 5.74% 10.76% 8.80% ROE 28.26% 16.68% 1.96% X X 17.50% Other Ratios: Altman Z scored 6.55 4.68 X X 5.08 4.65 Payout ratio 25.00% 25.00% 25.00% 0.00% X 20.00% Notes: a. Uses cost of goods sold as the numerator. b. Uses net sales as the numerator. c. Assume a 360-day year. d. Altmans function is calculated as Z = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.999X5 Here, X1 = net working capital/total assets X2 = retained earnings/total assets X3 = EBIT/total assets X4 = market value of common and preferred stock/book value of all debt X5 = sales/total assets. The Altman Z score range of 1.812.99 represents the so-called zone of ignorance. Note that the first four variables are expressed as percentages. Refer to Chapter 26 of Eugene F. Brigham and Louis C. Gapenski, Intermediate Financial Management, Fourth Edition (Fort Worth: Dryden Press, 1993), for details. e. Year-end balance-sheet values were used throughout in the computation of ratios embodying balance-sheet items. f. Assume constant industry-average ratios throughout the period 1990 through 1994. Case: 35 Financial Analysis and Forecasting"