TRUE THREAD LTD.
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Jeff Mathew, Chief Financial Officer of True Thread Ltd., was preparing for a meeting with his company's bank later in
the week. At that meeting, Mr. Mathew intended to present a request that the bank grant True Thread a five-year
loan to finance anticipated growth in the company and the expansion of the company's warehouse facilities.
In preparation for his meeting, Mathew had gathered some recent financial statements for True Thread (see Exhibit 1).
COMPANY BACKGROUND
True Thread Ltd. (TTL) was a rapidly growing retail distributor of automotive tires in Kerala. Tires were sold through a
chain of 10 shops located throughout central districts of Kerala. These stores kept sufficient inventory on hand to
service immediate customer demand, but the bulk of TTL's inventory was managed at a central warehouse outside
Kochi, at Kalamassery. Individual stores could be easily serviced by this warehouse, which could usually fill orders from
individual stores within 24 hours.
For the year ended in December 2015, TTL had sales of ₹23,505,000. Net income for that period was ₹1,190,000.
During the previous three years, sales had grown at a compound annual rate in excess of 20%. This record was a
reflection of True Thread's reputation for excellent service and competitive pricing, which yielded high levels of cus-
tomer satisfaction.
PAST RELATIONSHIP WITH FEDBANK
In 2011, TTL had borrowed funds from FedBank to build a warehouse. This loan was being repaid in equal annual
installments of ₹125,000. At the end of 2015, the balance due on the loan was ₹875,000. Also, in 2011 TTL established
a line of credit at FedBank. The company had not yet borrowed any money under this credit arrangement.
CURRENT FINANCIAL NEED
TTL had decided to expand its warehouse facilities to accommodate future growth. Indeed, the current warehouse
facilities were practically bulging at the seams. During the next 18 months, TTL planned to invest ₹2,400,000 on its
expansion, ₹2,000,000 of which would be spent during 2016 (no other capital expenditures were planned for 2016 and
2017). This expansion would fulfill the company's anticipated needs for several years. The warehouse construction
project was expected to be completed in early 2017. Therefore, TTL would not be able to deduct any depreciation on
the new building in 2016. However, Mr. Mathew was told by his accountant that in 2017, TTL could rec ognize a
depreciation expense of 5% of the warehouse's total cost. The dollar value of TTL’s depreciation expense on its other
assets in 2016 and 2017 would be the same as it was in 2015.
The warehouse expansion project was designed so that disruption of the company's current operations would be
minimized. However, management expected that by the end of 2016, TTL would temporarily have to decrease its
inventories to a level of ₹1,625,000, significantly lower than the ₹2,190,000 shown on the balance sheet at the end of
2015. This cutback in inventories was expected to last only until the warehouse construction project was completed in
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Professor W. Carl Kester prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
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Case 1: True Thread
early 2017. Mr. Mathew had estimated that, by the end of 2017, inventory would rise back to the same proportional
relationship to sales that it had in 2015.
EXHIBIT 1: FINANCIAL STATEMENTS OF TRUE THREAD (IN THOUSANDS)
For Years Ending 12/31 2013 2014 2015
INCOME STATEMENT
Net sales ₹ 16,230 ₹ 20,355 ₹ 23,505
Cost of sales 9,430 11,898 13,612
Gross profit 6,800 8,457 9,893
Selling, general, and
5,195 6,352 7,471
administrative expenses
Depreciation 160 180 213
Net interest expense 119 106 94
Pre-tax income 1,326 1,819 2,115
Income taxes 546 822 925
Net income ₹ 780 ₹ 997 ₹ 1,190
Dividends ₹ 155 ₹ 200 ₹ 240
BALANCE SHEET
Assets
Cash ₹ 508 ₹ 609 ₹ 706
Accounts receivable 2,545 3,095 3,652
Inventories 1,630 1,838 2,190
Total current assets 4,683 5,542 6,548
Gross plant & equipment 3,232 3,795 4,163
Accumulated depreciation 1,335 1,515 1,728
Net plant & equipment 1,897 2,280 2,435
Total assets ₹ 6,580 ₹ 7,822 ₹ 8,983
Liabilities
Current maturities
₹ 125 ₹ 125 ₹ 125
of long-term debt
Accounts payable 1,042 1,325 1,440
Accrued expenses 1,145 1,432 1,653
Total current liabilities 2,312 2,882 3,218
Long-term debt 1,000 875 750
Common stock 1,135 1,135 1,135
Retained earnings 2,133 2,930 3,880
Total shareholders' equity 3,268 4,065 5,015
Total liabilities ₹ 6,580 ₹ 7,822 ₹ 8,983
Other than this temporary drop in inventory in 2016, the warehouse expansion was not expected to affect TTL’s
operations in any other material respects. Operating margins were expected to be consistent with recent past
experience (the temporary drop in inventory would not affect cost of goods sold as a percent of sales, for example).
Likewise, current accounts other than inventory were expected to maintain steady relationships to sales. Cash
balances, for instance, would be maintained at a level of 3% of sales during the next two years. Although the Federal
statutory marginal corporate tax rate was 35%, the average tax rate on TTL’s pre-tax income had typically been higher
than this due to miscellaneous local taxes. This higher overall level of taxation was expected to continue in the future
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Case 1: True Thread
at rates consistent with the most recent past experience. In view of this anticipated stability, Mr. Mathew expected
TTL’s dividend payout policy to remain unchanged in the foreseeable future.
TTL had preliminary discussions with FedBank about borrowing money to finance the warehouse expansion and the
growth of the business. The proposed terms of the financing called for taking down (i.e., borrowing) the loan in two
separate parts on an as-needed basis: one in 2016 and one in 2017. The loan would be repaid in four equal annual
installments. The first installment payment would take place one year after the construction of the warehouse was
completed (i.e., in 2018). The interest rate was set at 10% per year.
MR. MATHEW'S TASK
In preparation for his meeting, Mr. Mathew intended to develop a set of pro forma financial statements for the
company. He and his staff had projected a 20% increase in sales each year in 2016 and in 2017, from ₹23,505,000 to
₹28,206,000 and ₹33,847,000, respectively. Mr. Mathew's first priority was to predict what the rest of the income
statement and the balance sheet for the firm would look like at the end of 2016 and 2017.