Tire City, Inc. is a rapidly growing retail distributor of automotive tires. Although they have 10 shops located throughout the Northeast region, the bulk of TCI’s inventory is managed at a central warehouse. During the last three years, sales have been growing at a compound annual rate in excess of 20%. With such a great reflection of their excellent service and customer satisfaction in their net income, TCI’s central warehouse is “bulging at the seams”. TCI has decided to expand its warehouse facilities to accommodate future growth, and has requested a five year loan. We, MidBank, previously financed a project for TCI in 1991, which is currently being repaid in equal annual installments. TCI plans to invest $2,400,000 on its expansion, $2,000,000 to be spent in 1996. In order to establish whether or not Tire City, Inc. will be a reliable debtor, and to determine appropriate loan amounts in 1996 and 1997, we produced pro forma financial statements given Mr. Martin’s projection of 20% annual increases in sales, as well as more conservative projections of 15% and 10%.
See Appendices 1 (A-C) to view the pro forma Income Statements. In order to achieve an accurate projection of Net Income, we had to make a number of assumptions about the behavior of various accounts. We assumed Net Sales would grow by 20%, 15%, and 10% in 1A, 1B, and 1C, respectively. Based on prior years’ data, we assumed Cost of Sales would remain at 58% of Net Sales. We also assumed Selling, General, and Administrative Expenses would grow at 20%, 15%, and 10%, respectively. TCI will not be allowed to deduct any depreciation on the new building in 1996, but will be able to deduct 5% of the warehouse’s total cost of $2,400,000 in 1997. Depreciation Expense on all other assets held by TCI will remain the same in 1996 and 1997 as it was in 1995. We assumed Net Interest Expense would remain at the average percentage of Long-Term Debt as it had in 1993, 1994, and 1995 with respect to existing obligations, and then tacked on 10% of the new external financing needed related to the new loan in 1996 and 1997. We assumed the tax rate on TCI’s pre-tax income would remain at approximately 43.74%, as it was in 1995. Given that the dividend payout policy was expected to remain unchanged in the foreseeable future, we set Dividends at 20% of Net Income.
See Appendix 2 (A-C) to view the pro forma Balance Sheet.
Before you analyze this financial statement, take note to certain assumptions. In 1996, TCI will have to temporarily decrease its inventories to a level of $1,625,000 because of a disruption of the company’s operations due to the expansion project. TCI has estimated that by 1997, inventory will rise back to the same proportional relationship to sales that it has in 1995. TCI’s other operations should not be affected, and are expected to have operating margins consistent with recent past experience. Cash Balances, for example, will be maintained at a level of 3% of sales for the next two years. Given that information, we projected things like Accounts Receivable, Accounts Payable, and Accrued Expenses from their previous percentage of sales as well. Statement of Cash Flows
See Appendix 3 (A-C) to view the pro forma Cash Flow Statement.
The way a company finances its assets can affect the nature of the investments it is able to undertake in future years. To maintain productive capacity and to finance additional growth, TCI must invest its newly received cash in new fixed assets: the warehouse. The point of creating a Cash Flow Statement for TCI is to prove that the cash returning from the investment cycle exceeds the amount that started the process. We also want to prove that TCI has sufficient cash to pay its maturing obligations, and potentially future maturing obligations. Basically, we want to make sure TCI is solvent.
According to our projections, TCI will remain solvent throughout...