Tire City, Inc. is a rapidly growing retail distributor of automotive tires in the northeastern United States. The stores held adequate inventory, on hand, to service all immediate customer demand. The bulk of the company’s inventory was managed at an outside warehouse which was easily serviced by the warehouse. The orders were usually serviced with in a 24 hour period. The company was able to maintain such happy customers since they had fast service and competitive prices.
During the previous three years at Tire City, the company had experienced a compounded annual sales increase in excess of 20%. In order to properly anticipate expected growth over the next couple of years, the company was looking to expand its warehouse facilities. Due to the companies rapid growth its current warehouse is bursting at the seams causing a delay in products.
The cash flow forecast predicts that 1996 sales, $28,206, will increase to $33,847 for 1997. For every dollar of this increase, $1056.44 net investment in working capital is needed. This investment is used to support higher sales in 1997. Under this set of assumptions, Tire City has excess cash of $273.31 at the end of 1996 given management decides not to create any decision cash flows. This is very unrealistic that management will not take on any decision cash flows.
This kind of fast growth rate would require capacity expansion investments. The company needs to start investing 1760.8 in the near future. The negative CATO in 1996 is due to the significant investments in working capital and capacity expansion in order to support high sales growth.
This is an extreme of how the management might deal with a recession. The company continues to service and distribute tires at a rate of 20% sales growth rate. The CATO row shows that there is trouble already at the end of 1997 with CATO equal to -$378. The managers could maintain liquidity if they have enough flexibility to react quickly to the recession....
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