QUESTIONS 1. Calculate the firm's 1996 ratios listed in Exhibit 3. 2. Part of Hamilton's evaluation will consist of comparing the firm's ratios to the industry numbers shown in Exhibit 3. (a) Discuss the limitations of such a comparative financial analysis. (b) In view of these limitations, why are such industry comparisons so frequently made? 3. Hamilton thinks that the profitability of the firm to the owners has been hurt by White's reluctance to use much interest-bearing debt. Is this a reasonable position? Explain. 4. The case mentions that White rarely takes trade discounts, which are typically 1/10, net 30. Does this seem like a wise financial move? Explain. 5. Calculate the company's market-to-book (MV/BV) ratio. (There are 5,000 shares of common stock.) 6. Hamilton's position is that White has not competently managed the firm. Defend this position using your previous answers and other information in the case. 38 PART II FINANCIAL ANALYSIS 7. White's position is that he has effectively managed the firm. Defend this position using your previous answers and other information in the case. 8. Play the role of an arbitrator. Is it possible based on an examination of the firm's ratios and other information in the case to assess White's managerial competence? Defend your position. 9. (a) Are the ratios you calculated based on market or book values? Explain. (b) Would you prefer ratios based on market or book values? Explain. EXHIBIT 1 Holly Fashions' Income Statements: 1993-1996 (000s) 1993 1994 1995 1996 Sales Cost of goods Gross margin Administrative Depreciation EBIT Interest Taxes Net income $985.0 748.6 236.4 169.4 10.8 56.1 7.0 49.1 _19.7 $29.5 $1,040.0 774.8 265.2 202.8 11.4 51.0 6.0 45.0 18.0 $27.0 $1,236.0 928.2 307.8 236.1 13.6 58.1 5.0 53.1 21.2 $31.9 $1,305.0 978.8 326.3 249.3 14.4 62.6 4.0 58.6 23.5 $35.2 EXHIBIT 2 Balance Sheets of the Holly Fashions Company: 1993-1996 (000s) 1993 1994 1995 1996 ASSETS Cash $40.4 Receivables 153.2 Inventory 117.0 Other current 5.9 Current assets 316.5 Gross fixed 44.8 Accumulated depreciation (12.0) Net fixed 32.8 Total assets $349.3 $51.9 158.9 121.1 6.2 338.0 58.9 (23.4) 35.5 $373.5 $38.6 175.1 193.4 7.4 414.5 78.1 (37.0) 41.1 $455.5 $10.6 224.8 191.9 7.8 435.1 96.4 (51.4) 45.0 $480.1 (continued) CASE 6 HOLLY FASHIONS 39 EXHIBIT 2 (Continued) 1993 1994 1995 1996 LIABILITIES & NET WORTH Accounts payable Debt due Accruals Current liabilities Long-term debt Common stock Retained earnings Total L&NW $53.8 10.0 19.7 83.5 60.0 150.0 55.8 $349.3 $54.7 10.0 26.0 90.7 50.0 150.0 82.8 $373.5 $86.2 10.0 24.7 120.9 40.0 180.0 114.6 $455.5 $84.2 10.0 26.1 120.3 30.0 180.0 149.8 $480.1 EXHIBIT 3 Financial Ratios for the Holly Fashions Company: 1993-1996 (Present) 1996 Industry Average 1993-1996* 1993 1994 1995 Liquidity Ratios Current 3.8 3.7 3.4 2.6 1.7 1.3 1.6 .8 .6 Quick 2.4 2.4 1.8 Leverage Ratios Debt(%) 41.1 37.7 35.3 Times interest earned 41 57 71 7.4 3.9 1.3 8.0 8.5 11.6 Activity Ratios Inventory Turnover (CGS) 6.4 6.4 4.8 Fixed Asset Turnover 30.0 29.3 30.1 8.1 6.0 3.5 40 25 12 3.5 2.8 2.0 Total Asset Turnover 2.8 2.8 2.7 (continued) 40 PART II FINANCIAL ANALYSIS EXHIBIT 3 (Continued) (Present) 1996 Industry Average 1993-1996* 1993 1994 1995 Average Collection Period 56 55 51 Days Purchases Outstanding** 25 22 31 Profitability Ratios Gross Margin (%) 24.0 25.5 24.9 Net Profit Margin (%) 3.0 2.6 2.6 41 50 68 18 25 32 28 26 24 42 3.1 1.2 27.3 19.5 7.8 11.8 8.7 3.4 9.9 7.2 3.1 Return on Equity (%) 14.3 11.6 10.8 Return on Total Assets (%) 8.4 7.2 7.0 Operating Margin*** (%) 6.8 6.0 6.1 *The three numbers for each ratio are computed in the following way. Ratios for all firms in the industry are arranged in what is considered a strongest-to-weakest order. The middle number represents the median ratio; that is, half the firms in the industry had ratios better than the median ratio and half had ratios that were worse. The top number represents the upper quartile figure, meaning 25 percent of the firms had ratios better than this. The lower number represents the lowest quartile, that is, 25 percent of the firms had ratios worse than this. **This shows the average length of time that trade debt is outstanding. Also called the average payment period. Calculated as A/P + (CGS/360). ***Calculated as (EBIT + Dep)/Sales