Tire City Inc. Mr. Abdullah the CFO of the Tire City Inc (TCI) is preparing for a meeting with their bank later in the week. At the meeting he needs to present a request to the bank for funding requirement(s) for a long-term loan facility to finance the expected growth in the company and expansion of its warehouse facilities. The historical financial statements of the company collected by Mr. Abdullah are attached here with; Company Background Tire City is a rapidly growing retailer of automobile tires in Saudi Arabia. TCI sells tires through 15 locations throughout Saudi Arabia. All these stores keep sufficient inventory on hand to service immediate customer requirements but the bulk of TCIs inventories is kept at a central warehouse in Kharj just outside Riyadh. Each store can be serviced by this warehouse which could fill their extra orders within 24 hours Sales were growing for the last three years at a compound annual rate of 20% due to the excellent service level and customer satisfaction but after work on expansion of the warehouse was initiated the estimates were revised due to the changing economic condition in the country and now sales are expected to be increase by 10% p.a. each year from the previous years levels both in 1996 and 1997. But Mr. Abdullah is confident that this is a short-term phenomenon and sales will jump back to previous levels and TCI is pushing forward with the warehouse expansion Past Relationship with AlAmana Bank In 1991 TCI borrowed funds from AlAmana Bank to build the Kharj warehouse. This loan was being repaid in equal annual installments of SAR125,000. At the end of 1995 the balance outstanding was SAR750,000. Another line of credit for working capital requirements of TCI was also established in 1991 but it had not been utilized to date Current Financing Requirement TCI has now decided to expand the warehouse in Kharaj to accommodate future growth of the company. For this TCI has planned to expand the warehouse at a cost of SAR1,200,000 half of which will be spent in 1996 and the remaining in 1997 (TCI has no other capital expenditure plans for these two years). It is projected that this expansion will fulfill the companys requirements for many years to come, they expect the useful life of the warehouse to be 25 years and the warehouse building will be depreciated using the straight-line method during this time. The construction of the warehouse is projected to be completed in early 1997. TCI would not charge any depreciation on the warehouse during the construction phase in 1996. (You can assume that the SAR value of depreciation of other assets will continue to be the same as 1995 in 1996 and 1997) Page 2 The warehouse expansion has been carefully planned so that it will have very little disruptive effect on current operations of the company. However due to the ongoing construction work inventories would have to be reduced to SAR625,000 by the end of 1996 to make room for construction equipment and materials which will be stored on the same site. The level of inventories as a % of sales would revert to 1995 level as soon as the warehouse construction is completed in early 1997. TCIs operations would not be affected in any other way due to the ongoing expansion except for the drop in inventories level for the reason mentioned above. Operating Profit Margin will remain in line with the historical trend. Current Accounts (except for inventories) will maintain the same steady relationship with sales. Cash Balances / Overdraft or Short Term Loan required from Bank is one item that Mr.Abdullah is worried about and has asked his staff to determine what will be the ending level in 1996 and 1997 Although TCIs corporate tax rate is 35% but after adding miscellaneous local taxes the effective average tax rate for TCI had been historically higher and the same trend was expected to continue. TCI is expected to continue with the past dividend payout policy to make sure that the stock price of the company was unaffected during the construction phase. TCI had some preliminary discussion with AlAmana Bank about the modus operandi of how they can borrow money to finance the expansion project and the bank agreed that TCI can borrow money for the expansion project in two separate installments on an as-needed basis, one in 1996 and the other in 1997. The loan would be repayable in 6 equal annual installments. The first installment would become payable after the completion of the warehouse (i.e., starting in 1998). The interest rate offered is 9.5% per annum Requirement To prepare Mr. Abdullah for the meeting with the bank he needs answers to the following questions; 1. Pro Forma Income Statement for TCI for 1996 & 1997 2. Proforma Balance Sheet for TCI for 1996 & 1997 3. Can TCI delay borrowing the loan? For how many years, explain? 4. Impact on TCIs Net Income if they delay the loan?