lv1ln99,t Aelu

Tire City, Inc.

Jack Martrn. ChiefFinancial Oflicer

ol lire.CLr). lnc.. uas preparine tor a mee'ing

tirat meeting' Mr' Martin intended to

u"J1""t it the week.At

*itft no
"o-plunvi
grant rire
9','t-"^i::ll::i ::::J: ,ll?l:;''i,:]''ot''o
o,."nt u "o'L""n"lrt' i""u
rd\ rrL"!r'
the expansion ol lhe comoanv s warenou\r
and

irowth in the company

't

ments

etO'*U""'1"'iit *ttti"g'
1)
fo;Tire CitY

(see

CompanY Background
Tire City,

Inc (TCl)

Martin had g3thered \ome recent financial "-ale-

Exhibit

of automotive tires in
was a rapidly growing retail distributor
th'o"gh a chain of l0 shops located
Connecttsouthem New Hampshire' and northern

no'tr'"u't"i'iu"iii ;;;'ii,"" 'i"'" tJ

tr'tottglto"t'"ui";;""t;;;;"t;t'
deon ha d to slrvice inrnediate- customer
cut' These stores kept sufficient inventory
outside
tut -u"ug"d at a central warehouse
man4 but ihe bulk of TCI's inventory
warehouse'
easily serviced by this

could b-e
Wo'""*"', f'Au"""ft"'"ttslndividual stores. stores within 24 hours.
rtii oto"tt from individlal
*hi"h
Ner
"o"l;;;;;ily
rqq5' rcr had sales or s2l'505'000

i""';;;;;;;

F""h';#:;ii

ro,'itut

'

p"ioi

*ui-S

ou'Iq t:
'ib0'00o

income

pt""ious three vea's' sales had grown at

of cus-

pricing' whici yielded high levels

""'"n"""u';;";i;"i"it"i""tt"rzooloThisrecordwas{eflectionofrirecitv'sreputation for excellent service and competitive
lomer satisfaction'

Past Relationship with MidBank

In

1ee 1,

rcr

had

b':'"*:1,T*,:":-ylitil!,;"ol.,ll.flJffit"ffi ;HllT":::

Iine
i'l es abr shedthisacredit
::'iil1i11*':::'#;.t#'';i:T'il"ioi
arangement
under
monev
anv
u"tt"*ed

oI irerir at vid-

Et".k.

Th;*:;;;;rt"i't"i

v"t

Current Financiai Need

gro*th Infacilities to accommodate future
TCI had decided to expand its watehouse
During the
seams
the
p'""ti"Afv U"lging at
deed. the cunent warehouse fa"iliti""s"tiit"
of
$2,000,000
on its expansion,
next 18 months, TCI planaed a i-".i S';fOO,OO0
for
plamed
were
expendin.rres
which would be spent during 199;'(tt;;h"t ""pital
anticipated needs for sevtn"
nltriil
*o',,l'J
19g6 and 1gg7). Thi.
"o-pu"y's
to be completed in early
""p-.ioo
*ut
eral years. The warehouse
Professor

W carl

""rr'*itl"il.

pt"j""i

"tp""t"a

rather than
basis for class discussion
Kester prepared thls case as the

or

handlinq or an ddrrin:'lrdt !e 5itudtion'

"iJl"ri?J"" reel'""oective
bv the Pre'idenr

*,t'l'"-.':;:l;*::i:t"",i:,:'3:::::;i,"r'"liX',Ti,l. Js"d
"r.

copy,iehr@
(drr
ncrmission to leproduce mareflars,
'Boston,

sLored in a.rerr,evat sy,!em,

-electroni(, m-e.hani.,l,
or Harvard Businesr school
r nu'p"',"i'sion

l.:;;;_";;

MA O2163 No part of this pub

"*i' o, oy
in a sDlead,heeL. or u,ns-;tt"o'n any fo,-r',

;lt:,ii.ilil;, ;:ili"q. ''

to illustrate

o'n"*;'"-

ioui

,;,."uced,

u.y ''."on.

'17

"18 Intt'oductory

EXHIBIT

Etercises

Financial Stetements
for Tire City, Inc.

For Years Ending 12l31

INCOME 5TATEMENT
Net sales
Cost of sales
Cross profit
Sellinq, qeneral, .rnd ad'nini't'dlive expense5

Depreciation
Net interest exPense
Pre-tax income
lncome taxes
Net income

BALANCE SHEET
Assets

199

$16,230

$20,35s

$23,505

9,430

',l,898

--6;Eab

8,457

5,19 s

.6,352
1

2,115
925

997

155

200

508
2,545
1,630
4,683

1,1r0
$240

706

3,652
2,190
6,548
4,163
1,728

3,79 5
1,51 5

,897

2,2A0

$ 6,580

$ 7 ,822

$ 8,983

$ 12s
1,440
- 1,6s3

Net plant & equiPment

Current maturities of Iong-term debt

Accounls Payable
Accrued expenses
Total current liabilities

609
3,095

3,232
1,335

Cross plant & equiPment

Accumulated dePreciation

LIABILITIES

94

822

780

,471

,819

546

Tol al d5\els

213

$
$

Accounts receivable
lnventories
Total current assets

13,612
9,893

180
106

160

1"t6

Cash

1994

119

Dividends

1993

125

125

2,312

,32s
1 ,432
2,882

Long-term debt

1,000

875

Common stock

1,135

i ,'1 35
2,930

3,!q0

7,822

$ 8,983

Retained earnings
Total shareholders' equltY

lotal

,O42

1,1,45

1::
$ 6,580

lrabrlrtleS

3,218
750

I,I

35

on the new building

1997. Therefore, TCI would not be able to deduct any depreciation

recin 1996. However, Mr' Martin was told by his accountant that in 1997' TCI could
of
value
dollar
The
ogrri^ u o"p*.*iion expense of 5% of tire warehouse's total cost
as
be
the
same
on its other assets in 1996 and 1997 would
TtI's depr".iutiolt
"*p"nr.
it was in 1995.

The warehouse expansion project was designed so that disruption of the company's
current operations r,vould be minimized. However, management expected that by-.the
levd{ of
end of 1996. TCI wor.rld temporarily have to decrease its inventories to a
at the
sheet
$1.625,000, significantly lower than ihe $2,190,000 shown on the balance
warehouse
until the
end of 1995. This cutback in inventories was expected to last only
project was completecl in early i997. Mr' Martin had estimated that' by
to
"onroo.tion
il.r" .na of 1997, in'r"ntoty would rise back to the same proportional relationship
sales that it had

in

1995

|,,
v
b

Tire CitY

Inc l9

'Other than this temporary drop

in inventory in I996. the warehouse exnansion was
not expected to affect TCI'S operations in any other materjal respeqls. Operating margins were expected to be consistent with recent pa.t experience {rh","rpor"rv jrop
,n
inventoty would not affect cost of goods sold as a percent of sa1es. for erample t. Like_
wise. current accounls other than in'enrory were expected to mainrain ,readt
relationships to sa1es. Cash balances, for instance, would be maintained at a leveiof :"2 ot,
sales during the next two years. Although the Federal statutory marginal corporate
tax
rate was 3502, the average tax rate on TCI's pre-tax income had typically been higher
than this due to miscellaneous locai taxes. This higher overall level of taxation was ex_
pected to continue in the future at rates consistent with the most recent past eKperience.
In view of this anticipated stability, Mr. Martin expected TCI's dividend payout policy
to remain unchanged in the foreseeable future.
TCI had preliminary discussions with MidBank about borrowing money to finance
the warehouse expansion and the growth of the business. The proposed terms of the financing called for taking down (i.e., borrowing) the loan in two sepamte parts on an
as-needed basis: one in 1996 and one in 199'7. The loan would be repaid in four equal
annual installments. The first installment payment would take place one year after the
construction ofthe warehouse was completed (i.e., in 1998). The interest rate was set at
l0%o per year.

Mr. Martin's Task

In preparation for his meeting, Mr Martin intended to develop a set of pro forma financial statements for the company. He and his staff had projected a 20o% increase in

in 1996 and in 1997, from $23,505,000 to $28,206,000 and

$33,847,000, respectively. Mr. Martin's first priorily was to predict what the rest ofthe
income statement and the balance sheet.for the lirm would look like at the end of 1996
sales each year

and. 1991