Question No.

1
Calculate the Iirm's 1996 ratios listed in Exhibit 3.
Financial Ratios for the Holly Fashions Company: 1993 -1996

ndustry Average (1993 - 1996)
1993 1994 1995 Present
1996
Average
of
HF(1993-
1996)
Top 25%
companies
Average
50%
companies
Lowest
25%
companies
Liquidity Ratios

Current 3.8 3.7 3.4 3.6 3.6 2.6 1.7 1.3
Quick 2.4 2.4 1.8 2 2.2 1.6 0.8 0.6
Leverage Ratios
Debt (%) 41.1 37.7 35.3 31.3 36.4 41 57 71
Time interest earned 8 8.5 11.6 15.7 11.0
ursrx
r
r.'
3 9
v
:?i;3 u
Activity Ratios
nventory Turnover
(CGS)
6.4 6.4 4.8 5.1 5.7 8.1 6 3.5
Fixed Asset Turnover 30 29.3 30.1 29 29.6 40 25 12
Total Asset Turnover 2.8 2.8 2.7 2.7 2.8 3.5 2.8 2
Average collection
Period
56 55 51 62 56.0 41 50 68
Days Purchases
Outstanding
25 22 31 31 27.3 18 25 32
Profitability Ratios

Gross Margin {%) . 24 25.5 24.9 25 24.9 28 26 24
Net Profit Margin (%)j 3 2.6 2.6 2.7 2.7 4.2 3.1 1.2
Return on Equity (%Jf 14.3 11.6 10.8 10.7 11.9 27.3 19.5 7.8
Return on Total Asset
8.4"

7 7.3 7.5 11.8 8.7
3.4
Operating Margin (%) 6.8 6 6.1 59. 6.2 9.9 7.2 3.1
Question No. 2
!art oI Hamilton's evaluation will consist oI comparing the Iirm's ratios to the
industry numbers shown in Exhibit 3.
(a) Discuss the limitations oI such a comparative Iinancial analysis.
Tne limitations include that these ratios cover a long period Ior the industry while it more
speciIic Ior HF, so in order to be accurate and Iair the comparison should be made Ior
speciIic equal periods. Moreover Ratios can indicate that there is a problem but it doesn't tell
what is the type oI the existing problem and what is the Iactor that was responsible Ior it in
terms oI the industry ratios. Another limitation is that all the Iinancial data oI all companies
in the industry should be developed in the same way in order to be able to compare them.
(b)In view oI these limitations, why are such industry comparisons so Irequently
made?
They are so Irequently made because it helps the company to indicate how well in general it
is doing by cross sectional comparison with the whole industry and with speciIic
competitors..
Question o. 3
Hamilton thinks that the proIitability oI the Iirm to the owners has been hurt by
White's reluctance to use much mterest-bearing debt. Is this a reasonable position?
Explain.
Yes it is a reasonable position, since it was clear in the case that Mr. White has retired lots oI
long term debts and he preIerred to use the capital as a source oI Iinancing and so as a result
each partner had to contribute $15'000 in order to meet companies cash needs. Moreover over
the long period, the return oI equity has been decreasing sharply and it is lower than the
median oI companies. Tnis means that using the capital instead oI debt was not the correct
decision and so iI debt was used instead the partners would have had the opportunity to invest
the capital in more eIIicient long term investment rather than to be used to cover operating
activities.
Question No. 4
The case mentions that White rarely takes trade discounts, which are typically ,
1/10, net 30. Does this seem like a wise Iinancial move? Explain.
It doesn't seem a wise Iinancial move especially since their liquidity ratios are higher than the
top 25 oI the companies and so it means that it can easily pay their short term debts and
beneIit Irom the discount.
Question No. 5
Calculate the company's market-to-book (MV/BV) ratio. (There are 5'000 ...
shares oI common stock).
Book Value oI the company ? Common StQck-`Retained earnings
...;-u ../ iso'ooa`i49
!
8po~.$329
,
sod ":.:.:u.:u:,. *(..
15 7% 4360 224739
16 7% 4360 245136
17 7% 4360 266961
18 7% 4360 290313
19 7% 4360 315300
20 7% 4360 337371
The amount aIter tax 70 * 337371 $236160
(d) Redo your answer to part (c) assuming 8 percent is earned during years 1 to
10, 5 percent during years 11 to 15, and 7 percent in years 16 to 20.
Year nterest Rate Annuity Ace. Amount BT
o
1
2
3
4
5
6
7
8
9
10
11
12

14.
15
16
17
18
19
20


4360
8% 12000 12960
8% 12000 26957
8% 12000 42073
8% 12000 58399
8% 12000 76031
8% 12000 95074
8% 12000 107388
8% 4360 120688
8% 4360 135052
xr
4360 150565
5% 4360 162671
5% 4360 175383
5% 4360 188730
5% 4360 202744
.,5%, 4360 217460
7% 4360 237347
7% 4360 258627
7% 4360 281396
7% 4360 305759
7% 4360
The amount aIter tax 70 * 327162 $229'013
Market Value oI the company 55 -I 65 $60 per share.
2
ThereIore the company's market-to-book ratio (60 * 5000) - $0.91
329'800
Question No. 6
Hamilton's position is that White has not competently managed the Iirm. DeIend this
position using your previous answers and other inIormation in the case.
White was not eIIicient in managing the Operation Cycle oI the business, where he has
produced lots oI inventory and kept it until customers would come and so this has hold up the
capital invested in it. Also the average Collection period has also increased which has held
the capital two. Moreover the Average payment period was increasing without any need and
also it led to the lost oI trade discounts. Also he wanted to use the capital to Iinance the
company rather the debt which is not a right decision. In addition, the MV/BV is still $0.91
despite the Iact White didn't distribute dividend oyer the past Iew years.
Question No. 7
White's position is that he has eIIectively managed the Iirm. DeIend this
position using your previous answers and other inIormation in the case.
The company leverage ratios are higher even the top 25 oI the companies and this means it
doesn't suIIer any debts which reduces the risk oI not going bankrupted.
Question No. 8 j
4
!lay the role oI an arbitrator. Is it possible based on an examination oI the Iirm's ratios and
other inIormation in the case to assess White's managerial competence. DeIend your
position.
According to the inIormation provided in Ihe case, Wliite's management was unsuccessIul Ior
example:` ..
:
./ ... ..,....,......... ...,:..*,...'..- .................. .-..... .. -... .......... .:' .... ........... ~..:.......
(1) He didn't improving the Average collection period and he kept selling to retailers who were
owing the company lot oI money and so by doing so he increased the A/R and increased the risk
oI making these A/R uncollectible.
(2) Companies like HF should maintain a stable bank relationship. Debt avoidance has signiIicantly -
reduced HF's Iinancial Ilexibility since all projects are equity Iinanced. This cost the company even
more than the debt interest.
(3) More evidence were already mentioned in previous answers. :.
W Question No. 9
(a) Are the ratios you calculated based on market or book values? Explain.
The ratios are calculated on Book values since the inIormation were taken Irom the Iinancial
statements.
(b) Would you preIer ratios based on market or book values? Explain.
I preIer market values since they reIlect the current situation and thereIore they are more
accurate and very close to the reality.
Question o. 5
Based on your previous calculations and other inIormation in the case, what do you
recommend? JustiIy your answer.
%e first scenario
Invest both the $30'000 and the excess $3052 in the monthly market at 4 interest
rate.
The accumulated aIter-tax investment in 20 years is $156*612. The
Tax is deducted on the spot.
%e second scenario
Invest the $30'000 in a S!A and the excess $3052 in TDA.
The accumulated aIter-tax investment in 20 years is $186*095 (60*270 125*825).
The Tax is deIerred until year 20.
%e %ird scenario
Invest both the $30'000 and the excess $3052 in the TDA
The accumulated aIter-tax investment in 20 years is $236*160 iI invested in orthern
Annuities.
The. accumulated aIter-tax investment in 20 years is $229*013 iI invested in Modern
Investment Ior 15 years and then in orthern Annuities Ior the last 5 years.
The Tax is deIerred until year 20.
It was clear that he wanted a long-term, tax-sheltered investment and also he made it clear
that he won't need the money beIore the age oI 60. So according to the above Scenarios, the
third scenario is the best one and it seems that the highest earnings come Irom investing in
orthern Annuities, but also investing in Modem Investment and then in orthern Annuities
would be also an advisable and recommended option since the lowest interest oI 5 may not
be reachable and thereIore the amount oI $229*013 would represent the lowest earnings and
so the earning might exceed it. So Irom my point oI view, I would recommend investing in
Modern Investment Ior 15 years and then in orthern Annuities Ior the last 5 years.

Question No. 1
(a) The $30'000 oI excess liquidity is earning 5 percent compounded monthly in
a money market Iund. This is a 5.12 percent annualized return. How was this
determined?

Year o Accumulated
0 \ 30'000
1 30'125
2 30'251
3 30'377
4 30'504
5 30'631
6 30'759
7 30'887
8 31'016
9 31'145
10 31'275
11 31'405
12 31'536
ThereIore the return on investment aIter year is 31*536 -30'000 5.12
30'000
(b) This annualized return oI 5.12 percent results in an aIter-tax return oI 3.58
percent since taxes on any interest must be paid each year. How was this
determined?
AIter Tax annualized return Return beIore Tax - Tax expenses
5.12-(0.3* 5.12)
3.58

Question No. 2
Assume a 4 percent aIter-tax annual return will be earned in a money market
Iund. How much will be accumulated in 20 years iI the $30'000 remains in the -
money market and $3'052 per year is placed in the same investment? -;
FV oI all the investments | !V (FVIF) n-20, M A (FVIFA) n20, i4 |
........................ - |30'000 (2.191) -3'052 (29.778) | ---- .. .,- uu-.---.uuu..-u- ...
.
:
-|65730 90'882| .u-.u.'.- -.`i.- .u-..u.-:..u..-
$156'612