Finance Case Study: Tire City Financial Case

Tire City

After completing the forecast for Tire City for 1996 and 1997 you can see that the firm is in very good shape. As the Sales increase each year the expenses do not increase at the same level so the net income of the firm continues to increase. With this number increasing the firm will be able to cover the loan for the new building without having to raise too much capital outside. The amount that tire city is expected to spend is $2,400,000 which $2,000,000 of that is accounted for in 1996 and is put into Long term debt and Gross Plant and Equipment. While the remaining $400,000 will be accounted for in 1997. After adding this data along with the increases to sales data we can see that in 1996 to firm will have excess cash
in 1996 of 1,505,000 and excess cash of $1,214,000 in 1997. So with looking at this information Tire City should take out the loan because they have the funds to pay it back and they have the line of credit with the bank that will make it cheaper for them.
Since they have such an excess in cash they will not only be able to pay off this loan easily but they will be able to pay off the excess on the previous loan easily too. By going with the loan the net income of the company will not go down by a whole lot because the only account that will bring it down will be interest expense. If they were to use the funds that the company had already accrued then they would not be able to give off as much in dividends and that may make the stockholder unhappy. While if they get the loan they will have more in excess and may be able to give off more in dividends which will make the stockholders happier and may even turn more people into wanting to buy the stock of tire
city. One thing that does need to be done is that they need to manage their inventory a little better. In 1996 the inventory levels went down because they were unable to manage it between the two warehouses but in 1997 it went back up to its normal level. While overall this does not seem to be too bad, for someone who does not know about the company and just looks at the financial statements up till 1996 they may think that the firm is declining and they can not handle as much inventory as they could in the past. If the company could manage their inventory in 1996 in a better manner then an outsider looking at the balance sheet would see that the company is doing very well in almost every aspect. The financial health of the firm is overall doing very well.
The first thing I calculated to find this was the current ratio which I found out to be 1.8:1. Which means that the firm has assets that they could turn into cash if they needed to pay off some of their debt. Since the company doesn’t pay out a large dividend they have much more to put into a company, so even if they do take the loan they can continue to pay off the loan while continuing to keep the dividend level where it is. The firm is also able to sell off its inventory quite frequently. By calculating the inventory turnover ration you can see that Tire City sells of its inventory around 7 times a year. By calculating the payout ratio I was able to determine that Tire Cities dividends are 20% of their net income. This is an extremely high level and it the future it is something that could come to hurt them but as you can see from the financial statements they are fine for now. Tire City also generates more profit from the shareholders then it does from their own assets which means that if they lose some of their shareholders they may be in trouble. Tire Cities return on assets is only 11% so this shows that they rely more on their equity then assets for their profits. If Tire City does not change their reliance on their shareholders it could hurt them in the future. By looking at these ratios along with the increase in net income from year to year you can see that the firm is going to continue
to do well from year to year. With the edition of the new loan the company will be able to open their new warehouse that will allow them to create more inventories and keep track of it in a better manner. I feel that by looking at the data I came up with that the company should take out the loan but take it out for less then the value of the new warehouse. If the company takes the loan for a value of about $1,000,000 then they will be able to pay it off in a short period of time while not earning too much interest. The remaining part of the building will be payed off using the excess cash that the company has accrued over the past years. In taking this loan Tire City will be able to add a major addition to their company while not taking on to much debt or using up all of their excess revenue. With a loan of around $1,000,000 the firm would be able to raise more then half off the capitol for this project internally and only have to raise a little under half from outside the company. And with the line of credit that they started with Midbank in 1991 the interest rates will continue to be low so their interest expense will continue to be low and will not affect their net income to a great extent.