Judgment Case 8–1

Riding the Merry-Go-Round

Merry-Go-Round Enterprises, the clothing retailer for dedicated followers of young men’s and women’s fashion, was looking natty as a company. It was March 1993, and the Joppa, Maryland-based outfit had just announced the acquisition of Chess King, a rival clothing chain, a move that would give it the biggest share of the young men’s clothing market. Merry-Go-Round told brokerage firm analysts that the purchase would add $13 million, or 15 cents a share, to profits for the year. So some Wall Street analysts raised their earnings estimates for Merry-GoRound. The company’s stock rose $2.25, or 15 percent, to $17 on the day of the Chess King news. Merry-GoRound was hot—$100 of its stock in January 1988 was worth $804 five years later. In 1993 the chain owned 1,460 stores in 44 states, mostly under the Cignal, Chess King, and Merry-Go-Round names.

Merry-Go-Round’s annual report for the fiscal year ended January 30, 1993, reported a 15% sales growth, to $877.5 million from $761.2 million. A portion of the company’s balance sheet is reproduced below:

But Merry-Go-Round spun out. The company lost $544,000 in the first six months of 1993, compared with earnings of $13.5 million in the first half of 1992. In the fall of 1992, Leonard “Boogie” Weinglass, Merry-Go-Round’s flamboyant founder and chairman who had started the company in 1968, boarded up his Merry-Go-Ranch in Aspen, Colorado, and returned to management after a 12-year hiatus. But the pony-tailed, shirtsleeved entrepreneur—the inspiration for the character Boogie in the movie Diner —couldn’t save his company from bankruptcy. In January 1994, the company filed for Chapter 11 protection in Baltimore. Shares crumbled below $3.

Required:

In retrospect, can you identify any advance warning at the date of the financial statements of the company’s impending bankruptcy?