Tire City Inc

8/4/2019 TireCity Inc

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Tire City Inc

Current Financial Health Profitability Tire City has shown strong sales growth from 1993-

1995. Sales increased 25.42% in 1994, and 15.48% in 1995 respectively. They have improved

their profit margin in every year, 1993 had a profit margin of 4.81%, 1994 4.90%, while 1995 has

improved to 5.06%. Contributing to this improving margin was a decrease in Cost of Goods Sold

as a % of sales, and interest expense as a % of sales. TireCitys gross profit margin has

improved slightly through the years, 1994 saw 41.55% while 1995 saw 42.05% suggesting

that Tire City may be charging slightly higher prices or have found cheaper suppliers of tires.

Interest expense as a % of sales has decreased due to how they are paying off their original

warehouse loan in $125,000 increments. Asset Turnover Assisting the improving profit

margin Tire City has seen an improved asset turnover ratio. It has increased every year from

2.47x in 1993, 2.60x in 1994, and 2.62x in 1995. The main improvement for this increase is fixed

asset turnover, which improved in 1995 to 9.65x, from 8.93x in 1994. The increase is a result of

decreasing planet & equipment as a % of sales. One can conclude that the company purchased a

little more plant & equipment; however sales increased significantly thereby increasing fixed asset

turnover. A slightly offsetting factor was A/R turnover, it has decreased slightly from 6.58x in

1994, to 6.44x times in 1995. This is due to a longer collection time, which has rose from 55.5

days in 1994, to 56.7 days in 1995. TireCitys inventory turnover has also slightly declined,

from 6.47 in 1994, to 6.22 in 1995. This is due to a higher inventory period, in 1994 inventory was

sold off in 56.4 days, in 1995 this has slightly increased to 58.7 days. This is a result of a higher

inventory as a % of sales in 1995 compared to 1994, in 94 inventories were 9.03% of sales, in

95 they were 9.32%. Financial LeverageTire City has moved to reduce its financial leverage, its

assets to equity ratio has decreased every year from 2.01 in 1993, 1.92 in 1994, and 1.79 in

1995. This signals that they are reducing their risk levels and improving their solvency. Tire City

has strong operating cash flows to fund its day to day operations and pay down its warehouse

loan. They have yet to borrow from the line of credit established with Midbank. Its times interested

earned has improved significantly from 18.16x in 1994, to 23.50 in 1995. This has been a result of

higher net income and decreased interest expense. TireCitys cash conversion cycle has

increased from 71.2 days in 1994 to 76.8 days in 1995. This is due to a higher collection period

and shortened payable period compared to 1994. Liquidity Tire City has improving current andquick ratios from 1994, in 1995 the current ratio was 2.03 (from 1.92) and a quick ratio of 1.35

(from 1.29). They are having no problem generating cash from operations , in 1994 operating

cash flows were $989,000, and $830,000 in 1995. This reduction in cash flows was due to an

increase in spending on inventory to support its sales growth. Future Financial Health Profitability

After predicting future sales growth of 20% in subsequent years of 1996 and 1997. My pro forma

income and balance sheet predicts that the profit margin will rise in 1996 to 5.16%, and then fall


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back to 4.98% in 1997. Contributing to the rise in 1996 is a falling depreciation expense as a

percentage of sales and a slightly lower interest expense as a percentage of sales. Contributing

to the fall of the profit margin in 1997 is an increased depreciation expense as a percentage of

sales, since Tire City is allowed to write off 5% of the planned warehouse expansion that year.

Another reason is that interest expense as a percentage of sales has increased due to larger

amount of debt that has been taken on to fund the expansion of the warehouse. Asset

Turnover Tire City will see a declining asset turnover ratio in 1996 and 1997. They managed a

ratio of 2.62x in 1995, which later falls to 2.55x in 1996, and then 2.47 in 1997. Dragging down

the ratio is a slower fixed asset turnover which has resulted in the companys big investment in

fixed assetin 96 being the warehouse. In 1995 fixed assets were 27.11% of total assets

(10.36% of sales), in 1996 they were 34.64% of assets (14.97% of sales). Offsetting this slower

fixed asset turnover is an improved inventory ratio, inventory is now being turned over 10.05

times a year compared to 6.22 times in 1995. This has been due to the company raising

$565,000 in 1996 by selling off a significant amount of their inventory which has resulted in amore efficient turnover. In 1997 inventories come back to their previous levels in proportion to

sales, which in turn takes the inventory turnover back to 6.22x a year, this contributes to the

declining asset turnover in 1997. However in 1997 fixed asset turnover picks up again as a

smaller investment in fixed assets is made and sales increase 20%, as opposed to a huge

increased in fixed asset in 1996. Financial Leverage Tire City will see a fairly moderate increase

in financial leverage through 1996 and 1997. Asset to equity in 1995 was 1.79, the same ratio

found in 1996, and in 1997 the ratio is 1.82, a slight increase. Tire City makes a substantial

operating cash flow of $2,122,000, which can be attributed to them selling off a majority of their

inventory. In 1997 operating cash flows make a cliff dive down to $354,000, this can be traced tore-buying a large amount of inventories to make them proportioned to sales like they were in

1995. Times interest earned makes a rise in 1996 to 24.34x then falls back to 19.50x in 1997.

The rising sales and lack of an increasing depreciation expense in 1996 attributed to the gain as

well as a lower interest expense as a percentage of sales, while in 1997 depreciation expense

increased and interest expense as a percentage of sales increased to .48% from .38% in 1996.

Liquidity

TireCitys current ratio decreased in 1996 to 1.79x from 2.03x in 1995, this ratio however

improves in 1997 to 2.06. Quick ratios remain around the same levels in 1995. The current ratio is

reduced in 1996 due to the selling off inventories to fund operations in 1996, when the levels go

back to normal in 1997, this is what improves the current ratio. Overall Id have to say

that Tire City will be in a weaker financial position in 1997 compared to 1995. Looking at it from a

DuPont decomposition standpoint, you can see how ROE has decreased, the profit margin has

fallen, a slower asset turnover, and increased financial leverage. As a lender I would be willing to

loan Tire City the funds needed to expand their warehouse, they are showing positive operating


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cash flows on my pro-forma, and remain profitable. The times interest earned ratio remains high

and provides some safety in knowing they can cover their interest costs 19.50 times over in 1997.

Sensitivity Analysis Scenario A: Inventory is not sold off in 1996, and maintains its same

proportion to sales in 1995. As you can see above, REO, profit margin, and asset turnover are all

lower if we maintain a proportionate percentage of inventories to sales as 1995. A higher asset to

equity ratio results because of the extra LTD that must be taken out to support the purchase of

the inventory. Also take note that a higher inventory will result in a longer inventory turnover

period, which will lengthen the cash conversion cycle. The times interest earned ratio will fall

because of the interest that must be paid on the extra LTD. Also the current ratio will improve due

to more inventories in current assets. Scenario B: Tire City Depreciates more than 5% of the

warehouse cost in 1997 {draw:frame} {draw:frame} Ive made a data table using percentages

from the standard 5% depreciation all the way to 10% from the $2,400,000 warehouse amount.

As you can see there is in inverse relationship between rising depreciation and ROE / profit

margin. As depreciation expense increases the profit margin and ROE fall. The overall assetturnover increases because of an increased fixed asset turnover due to less amount of net plant

and equipment. Financial leverage remains constant throughout. {draw:frame} {draw:frame} The

data table represents different amounts of accrued expenses in the far left column and the

resulting ratios as well as operating cash flows. As you can see an inverse relationship occurs

with ROE and profit margin with accrued expenses falling. Asset turnover remains constant, while

assets to equity increases due to an increase in LTD to fund the hole in accrued expenses. An

important note is that operating cash flows turn negative around a level between 1928-2142,

an increasingly turn negative as Tire City is forced to expenses more readily instead of accrue

them. Scenario: Day receivables are reduced, 1997 is used {draw:frame} {draw:frame} As the

collection period is decreased andTire City collects its credit sales faster than it normally does in

1997, you can see how it has a robust effect on ROE and profit margin, both increase a good

amount as the collection period is reduced. Another positive effect is the lower assets to equity

ratio, which signals less financial risk. Operating cash flows increase significantly as cash is more

readily available Scenario: Day payables are increased, 1997 is used {draw:frame} {draw:frame}

Here you can see on the data table accounts payable is increased and thus the payable period is

increased,Tire City is taking a longer time to pay its suppliers. ROE and the profit margin

increase as cash can be held longer and a shorter cash conversion cycle will result as seen

above. Financial leverage is marginally decreased, and operating cash flows increase

substantially. Pro Forma Income Statement Pro forma Balance Sheet Cash Flow Statement

Ratios

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


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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 doesnt 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


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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 loanTire 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.

Collaborating with Others: I would like to know if we can work on the case with another student

to make things a bit easier and more productive, but still hand in separate copies.

If you wish to discuss the case with another student that's fine. However, if you are "borrowing his

spreadsheet" and modifying it slightly and/or "lifting his analysis" but putting it in your own words

the answer is NO!! It's always easier to work in a group but there is too much free ridership. I

HATE remoras (a tiny fish that gets a free ride and free eats but sticking to the belly of a shark).

Also, you already know the grade you'll be getting if your report and spreadsheet resemble

another student's. I don't make idle threats. In Class Example: I was wondering whether you

were going to post a completed version of the Financial Planning Spreadsheet on the net.

As far as posting a completed version of the Financial Planning Spreadsheet on the net, it is

already in your Financial Modeling book written by yours truly on page 83. Errata Update: On

page 1, towards the bottom of the page "At the end of 1995, the balance due on the loan..." is

$875 for 1995 which consists of $750 in Long-term debt and $125 in short term debt (labeled

Current maturities of long-term debt). This $875 for 1995 comes from the Long-term debt of $875

for 1994.

Accounting Conventions: One of the majorrules of accounting is that assets = liabilities, I am

rather certain that this is true in this case as well, but I am not 100% sure on that. Would you

please clarify that?


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Did you look at your accounting text to see whether this is a true statement? You need to revisit

your accounting principles. Finance doesn't exist in a vacuum. It builds on knowledge that you

learn in accounting, marketing, management, etc. The term "balance" sheet means things must

be in balance. Assets (your investments) must equal how you finance those investments (either

through debt and/OR equity). Debt is considered liabilities. What do you think the answer to your

question should be?? Financial Modeling: Do we use the assumption/income statement/balance

sheet that you use in the sample sheet or do we use the set up in the Tire City case?

You can model it whichever way you want to. Hey, it's like eating an OREO cookie. Some people

like to unscrew the cookie and eat the cream first, other people just put the whole cookie in their

mouth. I gave you an example where I like to put all of the assumptions on the top so that I can

easily find where I made my mistake. Sales: How can we find the sales increase for year 1993 if

we don't know the sales value for 1992? Use sales for 1993 as the base year.

Are we supposed to measure the annual increase in sales with 1993 for every year or are we

supposed to compare it to the previous year? The previous year seems more logical. And I'm

having trouble trying to figure out how I'm supposed to find the percentages for 1997 and the

forecasting for 1998.

I think that you answered your own question. What does "annual increase" mean? Does it mean

from one year to the next or from the base year to the year in question? The case suggests how

you derive the percentages for 1997 (see the paragraph on page 2 entitled Mr. Martin's Task).

Does the case ask you to forecast 1998??? COGS, Accounts Receivables, Accounts Payable,

etc: For the A/R in theTire City Case, do we just take the percentage of sales from the actual

income statement and balance sheets (years 1993 to 1995)? Or do we use the projected A/R

given in the green textbook (Corporate Finance: A Valuation Approach), where Projected A/R =

(projected average collection period)/365 x projected sales. Do a straight forward A/R as a

percentage of sales as stated in the case. The Benninga and Sarig (BS) give a variation of this

simple ratio. This case also entails following instructions so the formulas may vary from what the

BS book say

When forecasting future A/R, A/P, and inventories, do we also use the percentage of sales

technique? In chapter 6 of BS, they project A/R, A/P, and inventories by calculating the average

collection period, average payable period, and inventory days. Which method do we use? It's nice

to know that students are reading the BS book prior to doing the assignment. Both methods are

correct. We're doing a simple percentage as was demonstrated in class. More specifically,


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calculate the relevant historical ratios such as accounts receivable/sales. Next, look at the trend

in AR/Sales over time. Apply the applicable AR/Sales ratio * Projected Sales to obtain the

expected level of accounts receivable. Ditto for A/P and inventories. Question: Why are both

methods correct? Because we can use AR/Sales to obtain the average collection period. To

prove this, take out a piece of paper and pencil and do the math. It will work out.

I have a question about the percentage of sales technique we have to use for our pro forma

income statement and balance sheet. We use the historical percentages as references to

forecast future financial statements. The case mentions that current accounts and operations

margins were expected to be consistent with past experience and maintain steady relationships

with sales. Although percentages of each account to sales were very similar throughout the past

three years, they didn't have exact same number. For example, the percentages of COGS to

sales for 1993, 1994, and 1995 were 58.1%, 58.45%, and 57.91% respectively. Are we supposeto take an average percentage or just take an educated guess? How many decimal places in the

percentage we need to take? If we need to take an educated guess, everyone is going to have

slightly different percentages. For example, some may estimate the percentage of COGS to sales

for the next two years to be 58% while some may say 58.2%.

Why would they have to be exactly the same number? Also, why calculate the historical

percentage of sales ratios if you don't plan to use them in your decisionmaking process? Look,

forecasting is NOT a science although we have certain benchmarks to guide our predictions.

Given your example of 58% vs. 58.2%, suppose for illustrative purposes that sales are forecasted

to be $25,000 (this is a made up number). Then if you use a COGS to Sales of 58% you would

obtain $14,500 as the predicted COGs while if you use 58.2% the COGs is $14,550 for a

difference of $50. Does it matter is you are off by .2%? What if you did an IRR? (you don't need

to do it in this case). Would the IRR really change? When you covered statistics, you learned

about the mean and standard deviation which are used in combination to obtain the confidence

interval. What happens if an observation falls with the confidence interval? (Sorry but I can't give

you the answer. Thinking is what I want you to do.)

When forecasting items such as COGS, A/R, etc... on the 1996 &1997 financial statements, do

we have to figure out the percentage of sales for these items for years 1993-1995? For example,

I need to find the COGS for 1996. Do I need to figure out COGS/Net Sales for years 1993-1995?

Or do I use the percentage calculated from 1995 to forecast COGS?


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Please see the answer to the preceding question. Also, did you read your book and the financial

modeling notes?

I am also a little confused about the pro forma balance sheet. In your financial modeling book pg83, the pro forma balance does not either specify the components (cash, A/R, inventories) of

current assets or the components of current liabilities. Do we have to specify those components

when we do a pro forma balance sheet for Tire City? On page 131 of your financial modeling

book, a more complicated pro forma balance sheet does list those components. The reason for

this is to give you a simplified example that we could get through in 1 hour and 15 minutes. If I

had given you an example that looks exactly like the Tire City case, it would be very easy with

little thinking involved. Think of it this way. If cash to sales are relatively constant over time, A/R to

sales are relatively constant over time, AND inventory to sales are relatively constant over time,

doesn't this also mean that current assets to sales are relatively constant over time? Sincecurrent assets = cash & equivalents + A/R + inventory it follows that current assets as a

percentage of sales = current assets/sales = (cash + A/R + inventory)/ sales = (cash/sales) +

(AR/sales) + (inventory/sales) = cash as a percentage of sales + A/R as a percentage of sales +

inventory as a percentage of sales. A similar logic process follows for current liabilities. And YES,

you do have to specify each component.

For Liabilties in the tire city case, there are current maturities of long-term debt, accounts

payable, accrued expenses, which are not in your sample sheet, since you only ask for current

liabilites. I can calculate the long term debt from the tire city case, but am I also suppose to

calculate the accounts payable, etc. based on previous years?

Please read the answer to the preceding question. Dividends: There's no dividends in the basic

data balance sheets... and the numbers of all the data are different from the actual case itself...

You should ask for a refund from your accounting professor. Dividends aren't in the balance

sheet. They're in the income statement. Whatever earnings is not paid as dividends is "plowed

back" into the firm as retained earnings. Please read your accounting textbook regarding

dividends and retained earnings.

Should I take dividends as a function of net income or net sales?

Please re-read the case. Also, read the lecture notes and the book. What do we mean by the

dividend payout ratio? Capital Expenditures: The case mentions that TCI plans to invest $2.4


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million in expansion of which $2 million will be incurred in 1996 and $0 in 1997. Do we just ignore

the remaining $0.4 million of capital expenditure?

Please re-read the passage. If you don't get it, keep re-reading it until you do. The passage states

"During the next 18 months TCI planned to invest $2,400,000 on its expansion, $2,000,000 of

which would be spent during 1996 (no other capital expenditures were planned for 1996 and

1997)." Do we add the cost of the warehouse to the plant and equipment section of the balance

sheet?

This case not only deals with finance but accounting as well. What does your accounting textbook

say about how the purchase/cost of the warehouse affects the Property, Plant, and Equipment

(PPE) section of the balance sheet? Think in terms of "T" accounts. Suppose you purchase a

new pickup truck (a piece of equipment) for your business that costs $35,000. You wish to

finance the purchase of this truck by putting down $2,000 in cash and taking out a loan from the

auto dealer for the remainder of the purchase price ($33,000). How would this purchase affectyour balance sheet? You would increase your Equipment by + $35,000 and decrease your Cash

by - $2,000 in the Assets section of your balance sheet (the left hand side of your balance sheet).

You would also increase your LT Debt by + $33,000 (the right hand side of your balance sheet).

The effect of this transaction is that the left hand side has a net increase of + $33,000 and the

right hand side has a net increase of + $33,000. Thus, the balance sheet is in "balance" e.g. the

left hand side = right hand side. For all transactions, the left hand side and right hand side should

be in balance. What is left for you to also do is that this transaction will affect your income

statement as well since you can take depreciation on this piece of equipment.

Depreciation: For recognizing the depreciation expense of the 'total' warehouse cost, is it

referring to $2.4 million or just $2 million? For the depreciation expense of the other assets, they

mentioned that it would be the same as the dollar value of 1995. Does this mean that it remains

constant at $213 through the forward projections?

Once again re-read the passage and think about what you learned in your accounting class.

Suppose you purchased a car for $35,000. You put down $2000 before walking out of the show

room. For the next, 5 years, you pay $400 per month. What is the cost (purchase price) of the

car? If it says that it is the same dollar amount as in 1995, then it should be self evident what the

depreciation expense of other assets will be in 1996 and in 1997. In the tire city case, there is

deprection in the income statement, but not in your sample income statement. ARe we suppose

to calculate that?

Of course you are suppose to put depreciation in your income statement. Gee whiz. I stated in

the class that my example did not contain depreciation but that you need to consider depreciation

in doing the Tire City case. So why didn't I use depreciation in my example? Because if my


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example was almost exactly like the Tire City case, people would simply copy my example and

not THINK! I want to have people think and also link what they've learned in accounting to what

they are learning in finance. Financing: I'm not very clear about the financing of money from the

bank. First of all, does the financing package or rate obtained from Midbank affect the pro-forma

statement projections in any way or is the financing questions simply independent of the

construction of the proforma statement? IF Tire City can't finance their warehouse expansion

using all internal financing (e.g. retained earnings and cash), then this means that the firm needs

some source of external financing. Since the case suggests that the firm will use bank financing

from MidBank in the event that external financing is required (this is the PLUG), does the

financing rate affect the pro-forma projections? Suppose you wish to start a dot.com company.

You have $5,000 cash on hand and can raise an additional $5,000 from selling your stocks.

Depending on what you sell in your first year, you might have to borrow money from your local

bank. If you do borrow the money, does the interest rate that they will charge you affect your pro-

forma projections?

When it comes to interest expense for the new loan, do we assume that the full 10% will be

charged the year the loan is taken down? I had a hard time following the in-class example. The

in-class example, like the TireCity case, involves first finding the amount of external financing

that Tire City needs. The external financing (all of which is presumed to be NEW bank debt rather

than a combination of new equity and new debt) represents "the plug". Interest expense is partly

based on the new debt amount. For additional insight, please read the preceding question and

answer.

For the pro forma financial statements, are we assuming that TCI will take out the loan?

What does it state in the case? Please refer to page 2, the paragraph above Mr. Martin's

Task.

I understand that there are two interest expense regarding the old and new loan. And it alsostates explicitly that the interest rate is 10%. But do I use the same int. rate (10%) for the new

loan or I need to find out the interest rate charged to the old debt? In order words, besides having

two interest expenses, so there will be two different interest rates also? We just went over this in

class today. Please read the lecture notes. The interest rate on the NEW loan is at 10%. Is the

interest rate on the OLD loan also at the current interest rate or the existing interest rate? Hmm....


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When we use external financing as the "plug", do we take the external financing in one year and

posted it as debt in the next year?

The way to think of external financing as the "plug" is to ask given that I plan to put new plant andequipment on my books e.g. increase my assets (the left hand side of the balance sheet), how

am I going to finance these new assets? Am I going to increase my debt or increase my equity

(the right hand side of the balance sheet)? In the case, it suggests that the firm's owner wishes to

fund new plant and equipment using debt financing e.g. issuing bonds or borrowing the money

from the bank. Thus, how much "new" debt is required in each period? "New" is defined as

anything that is not existing debt as of the end of 1995 (the period prior to the forecast period).

How do we calculate the net interest expense? Because I tried to divide it by the net sales from93-95, but the percentages vary. They are more stable when I divide it by gross profit. Is that

what I use to calculate it?

Interest does not vary with sales. Please read Chapters 3 and 4 of your textbook (RWJ) and also

dust off your accounting textbook. Also, it is very clear that you did not go through the example on

page 83 of my Financial Modeling book using an Excel spreadsheet. Why?

Staged-in Financing:

Could you explain the meaning of taking down the loan into 2 separate parts. It is unclear in the

case. Does this mean that each separate loan is to be repaid in 4 separate annual installments

e.g. there is a first installment for the loan taken in 1996, and a separate first loan installment to

be paid in 1997? As all installments paid in 1998, will they affect the pro-forma statement or are

they just there so we can make the relevant calculations to see if the bank should extend the loan

package to Tire City?

Taking down the loan in two separate parts on an as-needed basis means that suppose you have

a line of credit with the bank for say $500,000 (that at any time, the bank will lend you at up to$500,000) and in 1996 you require $200,000 in external financing then you would borrow

$200,000. If you borrow $200,000 then you have a maximum left on your line of credit of

$300,000 which you can use when you need additional financing. "Taking down" the loan means

that you set how much you borrow in each period. The maximum amount of all borrowings, using

my contrived example, is $500,000. Thus, you can borrow $100,000 this year, $100,000 next

year and $300,000 the subsequent year or you can borrow $400,000 this year and $100,000 next


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year. It's up to you. You decide when you need the money. Taking down the loan has nothing to

do with loan repayment. Taking down deals with borrowing the money. Repayment deals with

how and when you pay the money back to the bank. It says in the case that the loan is repaid in 4

equal installments. Thus, if you borrow $500,000 (suppose you don't do this all at once), the bank

will require that $500,000/4 = $125,000 is paid each year. The $125,000 paid each year assumes

that BOTH principal and interest are paid per period. This is NOT what typically happens. Recall

in class that a bond is debt. Suppose once again that you borrow $500,000 by issuing bonds.

Assume that the contract rate of interest is 6%, interest is paid annually, and the bonds mature in

4 years. What is the equal annual payment each year? It will be 6%*$500,000 = $30,000 in

interest. At the end of year 4, the principal amount of $500,000 is due. Several of you have asked

where does interest go on the balance sheet. It doesn't. If you go back and LOOK at your

accounting text, interest is posted to your income statement. Write-Up: Do the analysis we need

to write for the ratios be in MS Word format or can I write the analysis right there in Excel

under the actual figures? If you were doing this presentation for your boss, would you put the

analysis right there in Excel under the actual figures? Remember that you can use this case on

job interviews. How? Simply by waiting for the right "opening" e.g. in response to a question

about which is your most challenging course or who was your toughest professor at Stern and

why? This gives you the perfect opportunity to say this ##@@$%!! professor made the class to

resemble a finance boot camp wherein we had to do pro-forma analysis and other financial

modeling techniques. He also made sure that we could apply the corporate finance theories that

we learned in his class. Since you WILL be using for job interviews, do you want to signal what

type of person you are by writing the analysis in the Excel spreadsheet?

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