Need an analysis of the financial problems in the case study
Microsoft Word - M1101 - Corporate Finance - Pre-Course Assignment Fall 2020 - Final version.doc Corporate Finance M1101 Jacques Billy 19 – 21 November, 2020
[email protected] * Adapted from: ‘Cases in Financial Management’, Apilado et al., West Publishing Company, St. Paul, MN, 3rd ed, ISBN 0-314-29526-7 1 Pre-Course Assignment – Due 13th November 2020* The following book has to be read prior to the course: “Corporate Finance, Theory and Practice” by Pierre Vernimmen; Pascal Quiry; Maurizio Dallocchio; Yann Le Fur; Antonio Salvi. The whole book is highly relevant to this course, and very readable. More precisely, prior to this course and as a minimum, please read Chapters 1 to 5, 12, 41 and 48, preferably in the following order: § Chapters 1 to 5 give a general introduction to corporate finance. § Chapter 41 gives a brief overview of company’s structure. § Chapters 12 and 48 cover more specifically financing of a company and cash-flow management (some contents may be relevant to the case) FULLGRIP TIRE CO., INC. * Early in February, 2020, Victor Valdez, treasurer of Fullgrip Tire Company, Inc., asked the assistant treasurer, Jeanine Jackson, to analyze the corporation’s records to determine what financial problems might arise during 2020. Fullgrip is one of the twelve largest tire manufacturers in the United States, Ninety percent of Fullgrip’s sales and about 88 percent of its operating profits are derived from tire sales. Most of its tires are sold in the replacement market with significant sales to major retailers which sell tires under their store brand. Two-thirds of Fullgrip’s tire sales are for passenger cars with the remainder going to the truck, bus, and industrial vehicle markets. The business slowdown of 2015-2016, the slump in new car sales, and excess capacity in the industry put pressure on the profits of many tire manufacturers. Many consumers had postponed purchases of new automobiles during the recession, but there was no boom in replacement tire sales. Conditions improved significantly in 2018 and 2019, however. A number of tire manufacturers showed substantially higher profits in 2018 and 2019 compared with 2016 and 2017. Prospects for 2020 were uncertain for replacement tire manufacturers. The high level of new car sales had resulted in the retirement of many older cars which otherwise would have been candidates for replacement tires. Although the level of domestic new car sales might fall in 2020, low interest rates and special promotions might result in another big sales year for auto manufacturers. One bright spot for tire manufacturers was the importance of radial tires both as original equipment and replacements. Gas shortages in the 1980s followed by sharply escalating gasoline prices spurred the move to radial tires as fuel-saving devices. Radial tires sell for higher prices than bias-belted tires. From the tire manufacturers’ point of view, the bad news about radial tires is that they last longer than bias-belted tires. In the 1980s an auto owner could expect to buy five or six sets of replacement tires over the life of a car. Today three sets of radials normally run well over 100,000 miles. Rumors in the industry are that one of the major tire manufacturers will introduce a radial tire guaranteed to last for the life of the car. Corporate Finance M1101 Jacques Billy 19 – 21 November, 2020
[email protected] * Adapted from: ‘Cases in Financial Management’, Apilado et al., West Publishing Company, St. Paul, MN, 3rd ed, ISBN 0-314-29526-7 2 Fullgrip had not been an early producer of radial tires, and this had cost the company some sales. However, Fullgrip gained knowledge from other manufacturers’ experience in production of radials, and this helped when Fullgrip introduced its radial tire line. After a shaky start, the company made the transition, and currently most of its passenger-car tire production is in radials. A factor which could contribute to increased replacement tire sales is the use of undersized spare tires by American auto manufacturers. This should result in many replacement tire sales being in sets of four. Prior to this development, many consumers had purchased three new tires and used the spare tire, keeping the best of the used tires for a spare. Net income for Fullgrip has fluctuated in recent years as have dividend payment to common stockholders. Dividends of $480,000 have been paid annually on the corporation’s preferred stock which was sold in the 1990s. Directors have declared dividends in recent years (see Exhibit 1). Although directors were reluctant to do so, the dividends for common stockholders were slashed in 2015. The company’s common and preferred stocks are listed on the New York Stock Exchange, although trading in the preferred stock is relatively inactive. Exhibit 1 Fullgrip Tire Co., Inc.: Cash Dividends Paid, 2014-19 (thousands of USD) 2019 2018 2017 2016 2015 2014 Preferred stock 480 480 480 480 480 480 Common stock 4’300 900 400 nil 600 600 With this background, Jeanine Jackson began her analysis for Mr. Valdez. Although she had access to internal company records, Jeanine decided to start with the company’s balance sheets and income statements for 2019 and earlier which were just ready to be mailed to stockholders. These statements are shown in Exhibits 2 & 3. Corporate Finance M1101 Jacques Billy 19 – 21 November, 2020
[email protected] * Adapted from: ‘Cases in Financial Management’, Apilado et al., West Publishing Company, St. Paul, MN, 3rd ed, ISBN 0-314-29526-7 3 Exhibit 2 Fullgrip Tire Co., Inc.: Balance Sheets as of December 31, 2014-19 (millions of USD) 2019 2018 2017 2016 2015 2014 Current assets Cash 3 3 4 2 2 3 Accounts receivables 21 18 17 17 16 13 Inventories 44 42 34 36 31 28 Prepaid expenses 1 1 1 1 1 1 Total current assets 69 64 56 56 50 45 Plant and equipment 54 53 51 51 50 45 Less: accumulated depreciation 24 21 19 16 13 11 Net plant and equipment 30 32 32 35 37 34 Other assets: Investments 2 1 1 1 2 3 Total assets 101 97 89 92 89 82 Current liabilities Accounts payable 17 14 9 11 8 8 Notes payable 1 7 2 1 2 1 5 Accrued payables (including taxes) 11 10 9 9 7 8 Total current liabilities 35 26 19 22 16 21 Long-term liabilities Notes payable 1 21 26 26 26 28 15 Total liabilities 56 52 45 48 44 36 Net worth 6% Preferred stock 8 8 8 8 8 8 Common stock, $1 par value 2 2 2 2 2 2 Capital in excess of par value 10 10 10 10 10 10 Retained earnings 25 25 24 24 25 26 Total net worth 45 45 44 44 45 46 Total liabilities and net worth 101 97 89 92 89 82 Corporate Finance M1101 Jacques Billy 19 – 21 November, 2020
[email protected] * Adapted from: ‘Cases in Financial Management’, Apilado et al., West Publishing Company, St. Paul, MN, 3rd ed, ISBN 0-314-29526-7 4 1 Notes payable accounts include a $25 million loan from a life insurance company borrowed in 2015 with annual principal payments of $5 million due beginning June 30, 2020. Other notes payable, both current and long-term, were for borrowings from a commercial bank. EXHIBIT 3 Fullgrip Tire Co., Inc.: Income Statements for Years Ended December 31, 2014-19 (millions of USD) 2019 2018 2017 2016 2015 2014 Net sales 175 160 150 135 131 140 Cost of sales1 151 141 137 124 120.5 125 Gross Income 24 19 13 11 10.5 15 Selling, general, and admin. Expenses 12 11 8 7 7 9 Operating income 12 8 5 4 3.5 6 Interest expense 4 4 4 4 3 3 Income before taxes 8 4 1 0 0.5 3 Income taxes 3.2 1.4 0.3 0 0.1 1.1 Net Income 4.8 2.6 0.7 0 0.4 1.9 1 Includes depreciation charges of approximately $3 million annually. Task: Help Jeanine