case3_03

case3_03 - Capital Structure Policy 9 KLEEN KAR, INC. Kleen...

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Unformatted text preview: Capital Structure Policy 9 KLEEN KAR, INC. Kleen Kar, Inc., franchises automobile care centers throughout the southern United States. A com- plete Kleen Kar center includes a building with an automatic car washing bay and four service bays. The company also offers 10-minute oil changes and wax jobs for $15.95 each. Basically, the franchisee buys the exclusive right to use the Kleen Kar name within a given territory. In addi- tion, franchisees receive marketing and management support and have access to low-cost supplies such as soap, wax, and oil. Todd Lyle, a Louisiana State University graduate who founded the company in 1981, recog- nized the need for a fast and convenient automobile car care center. Customers of Kleen Kar could receive an oil change, wash, and wax in less than 30 minutes. Kleen Kar expanded rapidly from its base in New Orleans, first by opening company-owned stores in large cities in the South such as Miami, Orlando, Atlanta, and New Orleans, and then by franchising into other southern cities and towns. Todd was a firm believer in the virtues of equity financing. Although the company had used debt financing in the early years to finance the company-owned store expansion, Todd always used Kleen Kar’s cash flows to retire the debt as soon as possible. Recent growth has occurred from franchising, where the franchisee puts up the required capital. Thus, the company has not required outside capital in several years. Todd believes that the market for his company’s services has finally matured. First, numerous competing chains, such as the Mad Hatter, $12.95 Handwax, and Oil Can Henry’s, have appeared on the scene, and it now seems as if every town in the country with a population over 10,000 has at least one fast-food and one car care center franchise. Second, self-service gas stations, such as Mobil and British Petroleum, offer free automatic car washes with the purchase of gasoline. Third, many large oil companies, such as Pennzoil and Shell Oil, are entering the oil-change market and offer- ing even lower prices in order to gain market share. Thus, Todd expects Kleen Kar’s 1993 earn- ings before interest and taxes (EBIT) of $17 million to remain relatively constant into the foreseeable future. Kleen Kar has 10 million shares of common stock outstanding, which is traded in the over-the- counter market. The current stock price is $6, so the total value of Kleen Kar’s equity is $60 million. The book value of the firm’s stock is also $60 million, so the stock now sells at its book value. Todd owns 20 percent of the outstanding shares, and others in the management group collectively own an additional 10 percent. The company’s financial manager, Bill Joseph, has been preaching for years that Kleen Kar should use debt in its capital structure. “After all,” says Bill, “everybody else is using at least some debt, and many firms use a great deal of debt financing. I don’t want to put the firm into the junk bond category—that market has been hammered over the past few years-but I do Copyright © 1994. The Dryden Press. All rights reserved. think that judicious use of debt can benefit everyone. think that judicious use of debt can benefit everyone....
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case3_03 - Capital Structure Policy 9 KLEEN KAR, INC. Kleen...

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