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Decision

As a lender, I would lend money to Tire City. There are three things I am looking for as a lender in this situation. The first is liquidity, the second is solvency and the third is growth. Liquidity is important because I would not want to lend to a company that was already highly leveraged. That is not the case with Tire City, as the company has only 19% of its capital structure in long-term debt and its debt/equity ratio is 0.39. Solvency is important because I need to know that in the short-term, the company can make its payments. Tire City has over $1 million in cash, has a strong current ratio and a low level of current maturities ($125,000).

Given that the current financial position is strong, the third thing I want to know is that the company is expected to maintain a strong financial position going forward. For this I note that sales are increasing, the net profit margin is stable, and the expansion of the business in terms of assets, retained earnings, sales and profits has been stable over the past five years, it appears that the company is positioned to continue with this growth over the coming years as well. Note that the covenants were met as of fiscal 1996, and are met easily in fiscal 1997. The company might be required to lower its inventory temporarily going forward, but cash was not included in the net working capital calculation and if we include it, then the covenant should easily met. Also encouraging is the evidence in the inventory and asset turnover ratios that Tire City is tightening its cash conversion ratio steadily, as this indicates not only improved efficiency but also that the company will have more cash available with which to make payments. I see little reason to believe that Tire City would have any difficulty at all making repayments, and I see a lot of reasons why lending them money would be a good investment.