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'Reed's Clothier Case Study: Capital Budgeting

'Reed's Clothier Case Study

Read Case # 16, Reed's Clothier, located in:
EBOOK COLLECTION: Sulock, J. M., & Dunkelberg, J. (1997). Cases in financial management (2nd ed.). New York: John Wiley & Sons.

Disregard the financial statements and exhibits presented in the case.
Use the financial statements and exhibits presented here in place of those presented in the case.
Use the exhibits presented here to answer the following questions:

Reed's Clothiers Income Statement (in 000's)
Common Size
Reed Industry
Net Sales $3,054 100% 100%
Cost of goods 2,142 70.1% 67.0%
Gross profit $912 29.9% 33.0%
General & administrative expenses 561 18.4% 18.2%
Depreciation & amortization 48 1.6% 0.9%
Interest expense 96 3.1% 1.2%
Earnings before taxes $207 6.8% 12.7%
Income Taxes (@ 39%) 81 2.7% 4.9%
Net Income $126 4.1% 7.8%

Reed's Clothiers Balance Sheet (in 000's)
Common Size
Reed Industry
Cash $27 1.1% 1.5%
Inventories 738 30.9% 20.0%
Accounts receivable 621 26.0% 20.1%
Total current assets $1,386 58.0% 41.6%
Fixed assets 1,005 42.0% 58.4%
Total assets $2,391 100.0% 100.0%
Accounts payable $309 12.9% 9.3%
Notes payable 351 14.7% 6.4%
Other current liabilities 27 1.1% 0.2%
Total current liabilities $687 28.7% 15.9%
Long-term debt 906 37.9% 30.4%
Total liabilities $1,593 66.6% 46.3%
Stockholders equity 795 33.2% 53.7%
Total liabilities and stockholders equity $2,388 99.9% 100.0%

Exhibit 3
Reed's Clothier Aging Schedule
Days Past Due Amount (000's) Percent
0 - 29 198 32.0%
30 - 59 135 21.8%
60 - 89 135 21.5%
over 90 153 24.7%
621 100.0%

Reed's Clothiers Selected Ratios

Liquidity Ratios Industry
Current Ratio 2.7
Quick Ratio 1.6
Receivables Turnover 7.7
Average Collection Period 47.4
Efficiency Ratios
Total Asset Turnover 1.9
Inventory Turnover 7.0
Payable Turnover 15.1
Profitability Ratios
Gross Profit Margin 33.0
Net Profit Margin 7.8
Return on Equity 25.9

Exhibit 5
Reed's Clothiers
Year Inventories Net Sales
1991 567 2,718
1992 618 2,829
1993 678 2,931
1994 738 3,054

Reed's Clothier Case Questions:

1. Help write a brief summary of the case, explaining the situation facing Reed's Clothier, and what has caused the situation.
2. Exhibit 4 presents the industry average for ten financial ratios. Calculate these ratios for Reed's Clothier. Show all your calculations and provide a detailed explanation of what each ratio indicates about Reed's financial performance as compared to the industry.
3. Calculate Reed's Cash Conversion Cycle. Show all your calculations.
4. Why does Holmes want Reed's to have an inventory reduction sale, and what does he think will be accomplished by it?
5. Jim Reed had adopted a very loose working capital policy with higher current assets than industry averages. If he tightens his working capital policy to the averages, what affect will this have on his sales?
6. Assuming that Reed's can improve its operations to be in line with the industry averages, construct a pro forma income statement for Reed's Clothier for the year 2010. Assume that Net Sales will decrease by 5% to $2,901 ,000, and that depreciation and amortization expense will remain unchanged at $48,000.
7. Write a brief conclusion, summarizing the issues Reed's faces, and explaining what can be done to improve the company's performance.

Solution Preview

1. Reed's Clothier, a men's clothing establishment is facing financial difficulties. When the business was passed on to Jim Reed II from Jim Reed, Reed II took expansion plans and acquired a long term mortgage debt. During this time, inventory was also increased with a perception that increased inventories would lead to increased sales. The business grew and sales reached more than $2 million, but the increasing inventories along with acquired mortgage payments eroded the positive cash flow of the company. Reed also increased the credit line at his bank but failed to take advantage of supplier discounts. As a result many of the suppliers were overdue causing distrust among suppliers. Hence, aggressive approach towards increasing sales led to increasing inventories and taking long term debt which de-stabilized the company's financial position in the industry, the result of which can be seen in the ratios of the company.


Reed has poor liquidity as indicated by liquidity ratios. The current assets portion for the company does not carry much weight as compared to current liabilities or the current liabilities are much higher than that for ...

Solution Summary

The solution discusses Reed's Clothier Case Study regarding capital budgeting.