Case Solution Holly Fashion [PDF]

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Overview of the Case: Holly Fashion is a famous garments company located in Cherry Hill, New Jersey. Holly Fashion (HF) was started 14 years ago by William Hamilton and John White, who had over 25 years of experience with a major garments manufacture. Their partnership blended very well. Hamilton, reserved, is extremely creative with a rear flair for merchandising. As a result of his genius the HF level is synonymous with quality. White, outgoing and forceful, has contributed important merchandising and marketing ideas. Hamilton has had little interest in the financial aspect if the company. He preferred to work on designing new fashions and the development of marketing strategies. But a few months ago he deiced that he involved with the company’s financials. His motivation is twofold, and these are- First his considering the sale of 50% interest in HF.  He thought that he can better judge the managerial competence of White. When Hamilton got involved in company’s financial decision, some arguments between White and Hamilton got differ, as Hamilton was in company’s creative site and White was in the chief operating officer. When HF was small Hamilton thought White did a fine job but now he wonders whether White is capable of running a large firm or not, as company will face tougher time in the next few year. On the other hand as White was dealing virtually all major operating and financial decision he decided 3 years age to retire all long term debt as business risk was increasing. He also concerns the firm size and difficulty maintaining stable bank relationship due to increasingly strict federal regulations of some banks. Hamilton suspects that HF inventory is “excessive” while White position is that a large inventory is necessary to provide speedy delivery to customer. Hamilton always interested in giving trade discount while White rarely takes these discount decision because he wants to hold onto their cash as long as possible. However, the relationship between the two partners has been relatively smooth over the years. Hamilton admits that he may be unduly critical oh White’s management decisions.



Question and Answer: 1. Calculate the Firm’s 1996 ratios listed in Exhibit 3 Answer: Financial Ratios for the year 1993-1996 are bellow: A. Liquidity Ratios:Liquidity ratios are used to determine a company's ability to pay off its short-terms debts obligations.



Years



1993



1994



1995



1996



Current



3.8



3..7



3.4



3.6



Quick



2.4



2.4



1.6



2.0



B. Leverage Ratios: A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans), or assesses the ability of a company to meet financial obligations years



1993



1994



1995



1996



Debt ratio %



41.1



37.7



35.3



31.1



Time interest earned



8.0



8.5



11.6



15.7



C. Activity Ratios: Activity ratios are accounting ratios that measure a firm's ability to convert different accounts within its balance sheets into cash or sales. Activity ratios are used to measure the relative efficiency of a firm based on its use of its assets, leverage or other such balance sheet items. These ratios are important in determining whether a company's management is doing a good enough job of generating revenues, cash, etc. from its resources



Years



1993



1994



1995



1996



Inventory turnover



6.4



6.4



4.8



5.1



Fixed asset turnover



30..0



29.3



30.1



29



Total asset turnover



2.8



2.8



2.7



2.7



Average collection period



55



55



51



62.0



Days purchase outstanding



25



32



31



31.0



D. Profitability Ratios:Profitability ratios are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.



Years



1993



1994



1995



1996



Gross margin%



24



23.5



24.9



25



Net profit margin %



3



2.6



2.6



2.7



Return on equity %



14.3



11.6



10.8



10.7



Return on total asset %



8.4



7.2



7



7.3



Operating margin %



6.8



6



6.1



5.9



2. Part of Hamilton’s evaluation will consists of comparing firm’s ratios to the industry number shown in Exhibit 3a) Discuss the limitation of such a corporate financial analysis b) In the view of these limitations why such industry comparisons are so frequently made? Answer: a) The limitations of comparative financial analysis are: I. It is wrongly believed that as long as the firm being analyzed with a value better than the industry average, it can be viewed favorable, it’s therefore important to investigate significant deviation either side of the industry standard. II. Industry average is not particularly useful for analyzing firms with multiproduct lines. In the case of multiproduct firms, it’s difficult to select the appropriate benchmark industry III. Ratios with large deviations from the norm only indicate symptoms of a problem. Additional analysis is typically needed to isolate the causes of the problem, the fundamental point is: ratio analysis merely directs attendance to potential area of concern, it doesn’t provide conclusive evidence as to the existence of a problem. IV. The ratios being compared should be calculated using financial statements that published in the same date and same year. Otherwise it will provide wrong outputs



b) Industry comparisons are made for the following reasons: I.



II.



A single ratio doesn’t generally provide sufficient information from which the judge the overall performance of the firm, only when a group of ratios is used can reasonable judgment can be used, however, if an analysis is considered only with citrine specific aspects of the firm financial position, one ratio can be sufficient. Cross sectional analysis involve the comparison of different firms financial ratio at the same point in time, analysts are often interested in how will a firm has performed in relations to the other firms in its industry. Frequently, a firm will compare its ratio value to those of key competitors to it



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? Why? Answer: White’s reluctance to use much interest bearing debt has no effect and will not hurt the firm’s profitability. The firm’s interest bearing debts measure the firm’s ability to make contractual interest payment or to fulfill its interest obligations and have no relation to its profitability. 4. The case mentions that White rarely takes trade discount which are typically 1/10, net 30. Does this seem like wise financial move? Explain Answer: The Company is usually offered terms of 1\10, net 30, that is, the company’s one percent discount if it is paid in within10 days and in any event full payment is expected within 30 days. White takes these discounts he wants the liquidity or cash as soon as possible, in addition, the discount isn’t especially generous and 99 % of the bill must be paid. The decision is considered a wise financial move 5. Calculate the company’s market to book (MV/BV) ratio. (there are 5000 shares of common stock) Answer: Book value per share for common stock: $329,800\5000 share = $65.96 per share. Market to book value ratio (MV\BV) = $55\65.06 =$ 0.833 per share. 65\65.96 = $0.985 per share This means that the investors are paying $0.833 to $0.985 for each $1 of book value of holly fashions stocks.



6. Hamilton’s position is that White is not competently managed the firm. Defend this position using your previous answers and other information in the case. Answer:   







Hamilton thinks that the profitability of the firms to the owners has been hurt by White’s reluctance to use much interest bearing debt. Hamilton suspect that HF’s inventory is excessive and that capital is unnecessarily tied again inventory. Hamilton thinks that white has been generous in granting payment extensions to customers, and at one point nearly 40 percent of the company’s receivables were more than 90 days overdue. Hamilton wonders about the wisdom of passing up trade discount. HF is frequently offered terms of 1\10, net 30. That is, the company receives a one percent discount if bill is paid in10days and in any payment is expected within 30 days.



7. White’s position is that effectively managed the firm. Defend this position using your previous answers and other information in the cases Answer: 



 



White’s position in a large inventory is necessary to provide speedy delivery to customers. he argues that their customers expect quick service and a large inventory to them to provide that. White has been generous in granting payment extensions to customers because he doesn’t want to lose sales and that the rough time these retailers face is only temporary. White rarely takes cash discount because he wants to hold onto their cash as long as possible. Hamilton notes that the discount isn’t especially generous and 99 percent of the bill must be paid.



8. Play the role of an arbitrator. Is it possible based on a examination of the firm’s ratios and other information in the case to assess White’s managerial competence? Defend your position Answer: Looking at the comparison and analysis of the ratios with different years the Holly Fashions has experienced a lot of ups and downs within four years. There is increase and decrease in all ratios one can’t identify and realize any stable financial position, for example there is increase in inventory turnover and the Average collection period has been extended almost to 62 which is more and is not a good sign of sound Cash cycle and this can cause poor liquidity. On the other hand, the firm’s interest bearing debts measure the firm’s ability to make



contractual interest payment or to fulfill its interest obligations and have no relation to its profitability. White gave discount on the faster repayment which will motivate the borrowers to pay their liabilities on time and fast which will help them decrease the 62 days of collection and then they can pay the HF account payables.



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 Answer: a) All the calculated ratios are based on Book values which are recorded in the books of the firm. b) The calculations either to be book value or Market value depends on the firms Companies with lots of machinery, like railroads, or lots of financial instruments, like banks, tend to have large book values. In contrast, video game companies, fashion designers or trading firms may have little or no book value because they are only as good as the people who work there. Book value is not very useful in the latter case, but for companies with solid assets it's often the No.1 figure for investors. The following difference about the relationships between book value and market value can highlight which one to apply: 1. Book Value Greater Than Market Value: The financial market values the company for less than its stated value or net worth. When this is the case, it's usually because the market has lost confidence in the ability of the company's assets to generate future profits and cash flows. In other words, the market doesn't believe that the company is worth the value on its books. Value investors often like to seek out companies in this category in hopes that the market perception turns out to be incorrect. After all, the market is giving you the opportunity to buy a business for less than its stated net worth. 2. Market Value Greater Than Book Value: The market assigns a higher value to the company due to the earnings power of the company's assets. Nearly all consistently profitable companies will have market values greater than book values. 3. Book Value Equals Market Value: The market sees no compelling reason to believe the company's assets are better or worse than what is stated on the balance sheet



Recommendation Throughout the case we find that Hamilton and White have two different professional background and both wanted to take part in decision making so they differ in some argument. So we can say that   



Since the company is going through tough times, Hamilton should reduce the risk of not selling the company share. As Hamilton was from creative site so he should generate new idea to diversify their product. White always working with customers, he has the opportunity to maintain customers’ satisfaction so he should focus more on that site. Hamilton and White working together since 14 years, if they want to run their firm in a proper way they should keep their personal conflict aside.