California State Polytechnic University,

Pomona

GBA 645 Financial Decision Making

Professor: Paul Sarmas, Ph.D.

Case Report
Tire City Inc.
10/13/10

Team of Analysts:
Abeer Mandil
Joel Martinez

Backg
 Introduction

Tire City, Inc is a growing distributor of tires in the Northeastern part of the

United States. Tire City, Inc is positioned in eastern Massachusetts, southern

New Hampshire and northern Connecticut. Tire City, Inc distributes its

product through a chain of 10 stores and a central warehouse outside

Worcester, Massachusetts. In the past three years, Tire City has grown at an

annual compound rate of 20% which was attributed to its excellent

reputation for service and competitive pricing. Due to its growth, Tire City

is currently at maximum capacity in its warehouse and is considering

expanding its current warehouse facility to accommodate service levels.

Jack Martin and Abeer Mandil are in the process of presenting the financial

position of the company to their bank in order to request a five-year loan for

the expansion.

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 Case Analysis

1-Tire City, Inc. Financial Health for 1995

Liquidity

Liquidity Ratios 1993 1994 1995

Current ratio 2.03 1.92 2.03

Quick ratio 1.32 1.29 1.35

Cash ratio 0.22 0.21 0.22

Working capital ratio 0.36 0.34 0.37

Liquidity ratios are used to measure the company ability to meet its current
obligations.
Tire City Inc. has improving current ratio; it increased from 1.92 in 1994 to
2.03 in 1995.
Moreover, quick, cash and working capital ratios increased slightly in 1995.
Overall the company has good cash flow and stable position during 1993 to
1995.

Leverage

Leverage Ratios 1993 1994 1995

Debt ratio 50.33% 48.03% 44.17%

TIE coverage 12.14 18.16 23.50

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 L.T Debt ratio 0.23 0.18 0.13

Debt/Equity ratio 1.01 0.92 0.79

Equity multiplier 2.01 1.92 1.79

Lower debt ratio makes it easier for the Tire City Inc to borrow additional
funds without
Raising equity capital. Tire City Inc. has reduced its debt ratio from 48.03% in
1994 to 44.17% in 1995. Also, Tire City has improved time interest earned
coverage
from 18.16 in 1994 to 23.50 in 1995. The increased TIE coverage is due to
the higher net income and the decreased interest expense in 1995 than
1994. L.T Debt and Debt/Equity ratios has decreased slightly in 1995 than
1994 due to the decrease in the long term debt from $875,000 in 1994 to
$750,000 in 1995 (see appendix 1).

Asset Management

Asset Mgmt Ratios 1993 1994 1995

Inventory Turnover 5.79 6.47 6.22

Receivable 6.38 6.58 6.44

Turnover

Payable Turnover 9.05 8.98 9.45

FA Turnover 8.56 8.93 9.65

TA Turnover 2.47 2.60 2.62

Days Receivable OS 57.24 55.50 56.71

Days Inv OS 63.09 56.39 58.72

Days Payable OS 40.33 40.65 38.61

Cash Conv. Cycle 79.99 71.24 76.82

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 Asset management ratios are used to measure how effectively the company
is managing its assets. Tire City Inc inventory turnover declined from 6.47 in
1994 to 6.22 in 1995. The reason is the increasing inventory from 1994 to
1995 as a percentage of increased sales. Therefore, days of Inv outstanding
increased from 56.39 days in 1994 to 58.72 days in 1995. Also, receivable
turnover declined from 6.58 in 1994 to 6.44 in 1995 and accordingly days of
receivable outstanding increased from 55.50 days to 56.71 days. Tire City’s
payable turnover has increased from 8.98 in 1994 to 9.45 in 1995 and
accordingly days of payable outstanding decreased from 40.65 days in 1994
to 38.61 days in 1995. The Company cash conversions cycle has increased in
1995 to 76.82 days from 71.24 in 1994.

In the other side, Tire City’s has improved FA turnover; it increased from 8.93
in 1994 to 9.65 in 1995. The company TA turnover has increased slightly
from 2.60 in 1994 to 2.62 in 1995. The increased is due to the increased sales
and increased planet and equipment.

Profitability

Profitability Ratios 1993 1994 1995

Profit margin 4.81% 4.90% 5.06%

Gross PM 41.90% 41.55% 42.09%

Return on TA 11.85% 12.75% 13.25%

ROE 23.87% 24.53% 23.73%

Tire City was profitable in 1995. Tire City’s profit margin increased from 4.90%
in 1994 to 5.06% in 1995. This is due to the decrease of both COGS and interest

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 expense as a percentage of sales and the increase of sales. Also, gross profit
margin has improved from 41.55% in 1994 to 42.09% in 1995. Tire City’s ROA
has increased too from 12.75% in 1994 to 13.25% in 1995. While the ROE has
decreased slightly from 24.53% in 1994 to 23.73% in 1995.

2- Pro forma Blanca sheet & Income statement for 1996 -1997

We used percentage of sales methodology to forecast the pro forma. The

assumptions we used are based on growth of 20% for the sales and the
historical average of sales percentage for the years 1993 to 1995. After
calculating the pro forma as shown in the appendix the external financing
needed (bank debt) for 1996 -1997 will be total of
$ 1,393,000. In 1996 it will be $ 354,800 and in 1997 will be $1,038,260.
(See the appendix)

3-Tire City, Inc. Financial Health for 1997

Liquidity

Liquidity Ratios 1995 1997

Current ratio 2.03 1.66

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 Quick ratio 1.35 1.10

Cash ratio 0.22 0.92

Working capital 0.37 0.27

ratio

Tire City Inc. current ratio has declined from 2.03 in 1995 to 1.66 in 1997
.The Quick ratio also declined from 1.35 to 1.10. The reason is the expansion
in the warehouse ($2,400,000) which increased fixed assets and the AFN
needed. Tire City’s cash ratio increased in 1997 from 0 .22 in 1995 to 0.92 as
cash was increasing in 3% of sales. Working capital ratio increased slightly in
1997. Tire City Inc has reasonable cash flow in 1997.

Leverage

Leverage Ratios 1995 1997

Debt ratio 44.17% 45.10%

TIE coverage 23.50 28.25

L.T Debt ratio 0.13 0.06

Debt/Equity ratio 0.79 0.82

Equity multiplier 1.79 1.82

Tire City Inc has increased its debt ratio from 44.17% in 1995 to 44.10% in
1997 by planning to take the bank loan for the additional fund needed. Also,
Tire City time interest earned coverage increased from 23.50 in 1995 to
28.25 in 1997. L.T Debt decreased slightly in 1997 than 1995 due to the
decrease in the long term debt from $750,000 in 1995 to $500,000 in 1997.

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 Debut to equity ratio has increased slightly from 0.79 in 1995 to 0.82 in
1997.

Asset Management

Asset Mgmt Ratios 1995 1997

Inventory Turnover 6.22 6.18

Receivable 6.44 6.47

Turnover

Payable Turnover 9.45 9.18

FA Turnover 9.65 7.89

TA Turnover 2.62 2.47

Days Receivable OS 56.71 56.44

Days Inv OS 58.72 59.11

Days Payable OS 38.61 39.77

Cash Conv. Cycle 76.82 75.78

Tire City Inc inventory turnover declined slightly from 6.22 in 1995 to 6.18 in
1997. The reason is the inventory increased again in 1997 with the
percentage of increased sales after the reduced inventory in 1996.
Therefore, days of Inv outstanding increased slightly from 58.72 days in 1995
to 59.11 days in 1997 (almost unchanged). Receivable turnover increased
slightly from 6.44 in 1995 to 6.47 in 1997 and days of receivable outstanding
remained the same (56 days).

Tire City’s payable turnover has declined from 9.45 in 1995 to 9.18 in 1997
and accordingly days of payable outstanding increased from 38.61 days in

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 1995 to 39.77 days in 1995. The Company cash conversions cycle has
decreased in 1997 to 75.78 days from 76.82 in 1995.

Tire City’s has declining FA turnover from 9.65 in 1995 to 7.89 in 1997 and
the company TA turnover has declined from 2.62 in 1995 to 2.47 in 1997.
This is due to the investment in 1996 for the warehouse expansion

Profitability

Profitability Ratios 1995 1997

Profit margin 5.06% 5.02%

Gross PM 42.09% 41.85%

Return on TA 13.25% 12.37%

ROE 23.73% 22.54%

Tire City is still profitable in 1997. Tire City’s profit margin and gross profit
margin almost will stay stable in 1997. Tire City’s ROA decreased slightly in
1997 due to the increase in the TA. Also, ROE decreased slightly in 1997 with
the increased RE.

4-Sensitivity Analysis

a. If Inventory is not reduced at the end of 1996: the additional financing

needed will increase from a total investment of $1.393m to $2.470m.
This is primarily driven by a decline in the liquidity position of the
company as reflected by the downward trend in the liquidity ratios.
(See appendix)

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b. If accrued expenses grow less than expected:we assumed 5% instead
of 7% the AFN will increase from $1.393m to $2.684m total
investment. This is primarily due to the need for additional financing
to offset the increase in assets for the expansion investment. . (See
appendix)

c. If more than 5% of the total warehouse cost is depreciated in 1997:

we assumed 10 % then the need for additional financing needed
increases. This is due to a reduction in the net plant assets and a
reduction and also can be related to a reduction in ROE. (See
appendix)

d. If inflation if higher than expected: we assumed 25% this will create

higher prices and thus higher levels of revenue. But this also means
all corresponding expenses will increase a well resulting in an increase
in AFN needed from $1.393 to $1.630. This can be attributed to a
decrease in the working capital ratio and an increasing debt ratio. .
(See appendix)

e. As days receivable is reduced: the need for AFN decreases due to the
improvement in liquidity. With a $2m decrease in accounts receivable
the days receivable was reduced from 56.11 days to 25.6 days and no
need for external financing. . (See appendix)

f. As days payable increased: by reducing Cost of Goods sold and

increasing account payable by $2m, the days payable increased from
38.6 days to 108 days and eliminating the need for AFN. . (See
appendix)

Summary & Conclusion

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Tire City is in a good financial position as reflected by consistent liquidity

ratios, stable leverage even after the expansion project into 1997.

Additionally, asset management ratios have also been stable and as

discussed in the sensitivity analysis there is an opportunity to improve by

reducing receivables, delaying payables, and maintaining low levels of

inventory. Profitability ratios are forecasted to decline but not to a

significant level and in line with past historical performance. Tire City should

have no problem absorbing the expansion investment and maintaining

consistent profitability as shown in the forecast and financial ratios.

As an alternative recommendation Tire City should consider reducing

inventory their level to allow for improved liquidity and potentially avoid

additional financing needed. As was discussed in the sensitivity analysis

there is potential to reduce or avoid AFN. The proximity of the distribution

center to the stores and also the expectation to maintain service levels

despite reducing inventory in 1996; shows the ability to maintain service.

References

Kester, W. Carl. "Tire City, Inc." Harvard Business School Case 297-091

Ross, Stephen. Westerfield, Randolph. And Jordan, Bradford. Essentials of

Corporate Finance. Eighth Edition Irwin, 1996

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 Appendix

For calculations, please refer to the Microsoft Excel spreadsheet and tables in
the following pages.

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