Holly Fashions - Ratio Analysis

Question 1: Calculate the firm’s most recent ratios listed in Exhibit 3

Ratios

Year-3 Year-2 Year-1 Current year

Liquidity ratios

Current 3,8 3,7 3,4 3,6

Quick 2,4 2,4 1,8 2,0

Leverage ratios

Debt (%) 41,1 37,7 35,3 31,3

Times interest earned 8,0 8,5 11,6 15,6

Activity Ratios

Inventory turnover (CGS) 6,4 6,4 4,8 5,1

Fixed asset turnover 30,0 29,3 30,1 29,0

Total asset turnover 2,8 2,8 2,7 2,7

Average Collection Period 56,0 55,0 51,0 62,0

Days Purchases Outstanding 25,9 25,4 33,4 31,0

Profitability Ratios Gross Margin (%) 24,0 25,5 24,9 25,0

Net Profit Margin (%) 3,0 2,6 2,6 2,7

Return on Equity (%) 14,3 11,6 10,8 10,6

Return on Total Assets (%) 8,4 7,2 7,0 7,3

Operating Margin (%) 6,8 6,0 5,8 5,9

Question 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.

The company is frequently offered terms of 1/10, net 30. That is, the company is offered 1% discount if the bill is paid within 10 days, otherwise the bill has to be fully paid within 30 days.

The average interest rate of a bank loan is 3.3%.

• Possibility 1: Effective annual rate (EAR)

Due to the fact that we would only have to pay 99% of the total purchase price if we pay within 10 days, we have to calculate what it means to save this 1% in terms of an effective annual rate.

EAR (Effective Annual Rate) = (1 + APR/m)m - 1

APR (Annual Percentage Rate) = (discount rate/1-discount rate) * (365/days between payment days)

= (0.01/(1-0.01)) * (365/(30-10)) = 18.434

EAR = (1 + (0.01/1 – 0.01)365/20 – 1 = 0.2013 → ~20%

As we have an EAR of 20% which is larger than a bank loan of 3.3%, we should definitively take the bank loan to pay the 99% of the total purchase price within 10 days instead...