O'Ryan Auto Centers, a national auto parts chain, was seeking a way to expand into the Middle Atlantic region. Their investment bank proposed an acquisition of Tire City located in Somerset, PA, Tire City, a family-owned firm, had grown rapidly with an explosive 24% increase in sales in 2014 in part attributable to new store openings and expanded services. While the company had always generated healthy cash flow, this growth was straining the ability of the company to efficiently manage its assets. In 2015, Tire City had to borrow against its revolving line of credit for the first time during the year but had it repaid by year-end. Working with its investment advisor, GEC Capital, Tire City decided it was time to sell and was asking $20 million for the company. The investment banker for O'Ryan Auto Centers quickly brought the deal to Dudley Dean, the CFO of O'Ryan's. Mr. Dean thought the price was high when viewed as a multiple of 2015 EBITDA. This deal was at the high end of mid-market acquisitions where recent transactions ranged from multiples of 6.5-8.0X EBITDA. However, Mr. Dean thought that O'Ryan could easily improve the cash flow of Tire City with a new inventory management system and reduce overhead expenses as well. While the growth of Tire City may slow from its double-digit rates as more competition entered the space, Mr. Dean believed that Tire City could generate significant cash flows for O'Ryan's shareholders or for re-investment in the other parts of the company. command Mr. Dean sat down with his acquisition team and outlined some parameters for determining the opportunity. His goal was to determine (1) if Tire City could generate at least $2.0 million in operating cash flow over the next three years with a dividend payout ratio of at least 70% to O'Ryan; and (2) whether $20 million was a reasonable starting point for the negotiations. The team was given these parameters for a 3-year forecast to answer Mr. Dean's questions. I. Sales growth: 15% in 2016, 12.5% in 2017 and 10% in 2018. 2. An improvement in COGS/sales to 57% over the forecast horizon 3. A reduction in GSA/sales to 30% from 2016 onwards. 4. Accrued expenses/sales remains at 7% of sales; cash/sales remains at 396. 5. CAPX falls to 1.5% of sales. 6. Tire City's debt will be repaid in 2016 and replaced with a $750 thousand bank line available to O'Ryan (ignore all fees) that can be used to meet any funding deficits given the cash withdrawal (dividend) targets. The interest rate on this line of credit is 6% 7, A 35% tax rate (O'Ryan's rate) 8. O'Ryan's current capital structure consists of $120 million book value of debt currently selling at 95% of book value and an average yield of 6.5%. 20 million shares of stock outstanding currently trading at $72.50 per share O'Ryan's equity beta is 1.05, the current 10-year Treasury yield is 4.0% and O'Ryan's investment banker suggests the use of a 6.5% market risk premium. a. b. c. O'Ryan Auto Centers, a national auto parts chain, was seeking a way to expand into the Middle Atlantic region. Their investment bank proposed an acquisition of Tire City located in Somerset, PA, Tire City, a family-owned firm, had grown rapidly with an explosive 24% increase in sales in 2014 in part attributable to new store openings and expanded services. While the company had always generated healthy cash flow, this growth was straining the ability of the company to efficiently manage its assets. In 2015, Tire City had to borrow against its revolving line of credit for the first time during the year but had it repaid by year-end. Working with its investment advisor, GEC Capital, Tire City decided it was time to sell and was asking $20 million for the company. The investment banker for O'Ryan Auto Centers quickly brought the deal to Dudley Dean, the CFO of O'Ryan's. Mr. Dean thought the price was high when viewed as a multiple of 2015 EBITDA. This deal was at the high end of mid-market acquisitions where recent transactions ranged from multiples of 6.5-8.0X EBITDA. However, Mr. Dean thought that O'Ryan could easily improve the cash flow of Tire City with a new inventory management system and reduce overhead expenses as well. While the growth of Tire City may slow from its double-digit rates as more competition entered the space, Mr. Dean believed that Tire City could generate significant cash flows for O'Ryan's shareholders or for re-investment in the other parts of the company. command Mr. Dean sat down with his acquisition team and outlined some parameters for determining the opportunity. His goal was to determine (1) if Tire City could generate at least $2.0 million in operating cash flow over the next three years with a dividend payout ratio of at least 70% to O'Ryan; and (2) whether $20 million was a reasonable starting point for the negotiations. The team was given these parameters for a 3-year forecast to answer Mr. Dean's questions. I. Sales growth: 15% in 2016, 12.5% in 2017 and 10% in 2018. 2. An improvement in COGS/sales to 57% over the forecast horizon 3. A reduction in GSA/sales to 30% from 2016 onwards. 4. Accrued expenses/sales remains at 7% of sales; cash/sales remains at 396. 5. CAPX falls to 1.5% of sales. 6. Tire City's debt will be repaid in 2016 and replaced with a $750 thousand bank line available to O'Ryan (ignore all fees) that can be used to meet any funding deficits given the cash withdrawal (dividend) targets. The interest rate on this line of credit is 6% 7, A 35% tax rate (O'Ryan's rate) 8. O'Ryan's current capital structure consists of $120 million book value of debt currently selling at 95% of book value and an average yield of 6.5%. 20 million shares of stock outstanding currently trading at $72.50 per share O'Ryan's equity beta is 1.05, the current 10-year Treasury yield is 4.0% and O'Ryan's investment banker suggests the use of a 6.5% market risk premium. a. b. c