CASE12-1 HOME VALUE STORES [LO2]

Home Value Stores operates 264 membership ware- house stores in the United States, Europe, and Asia.The company offers low prices on a limited selection of house- hold and grocery products. In the past year, sales increased by approximately 10.8 percent and net earnings increased by 6.4 percent. The company opened only two stores in 2017 and 2018 and closed one of its stores due to poor performance. Jack Davidson and Michael Prine are on the board of directors of Home Value and serve on the company's compensation com- mittee. At a recent lunch meeting, they discussed the company's performance. (See the table on the next page for a balance sheet and an income statement.) Both were pleased with the increase in profit and decided to recommend a contract extension and a substantial six-figure bonus for the company's CEO. They an- ticipated, however, that the third member of the compensation committee, Tanya Barrett, would object to the bonus. Tanya believes that accounting profit is a poor measure of future firm performance. In her opinion, the company should be focused on what it is doing today to create future value for shareholders. She has also pointed out that, although the company showed quarterly profit increases, its stock price remained flat.

REQUIRED

a.To prepare for an upcoming board meeting, Tanya has asked you to evaluate financial performance for 2017 and 2018, taking into account both the level of investment and the cost of capital. Specifically, she would like you to calculate the level of profit (loss) that was earned in excess of the amount required given the investment in the company. Assume that the cost of capital is 15 percent. Is it clear that the company has had superior financial performance?

b.In fiscal 2019, the CEO of Home Value Stores retired. His successor is concerned that warehouse managers do not understand how their actions are linked to the company's strategy and how they can affect future firm value. In his opinion, while monthly earnings are important, managers are focused almost exclusively on how their actions affect these numbers. Suggest a performance measurement technique that can be used to address the new CEO's concerns.

Comparative Financial Statements: Home Value Stores (in thousands) Sales Merchandise costs Operating, general and administrative Rent Depreciation and amortization Interest expense Total Earnings before taxes Taxes Net earnings Assets Cash and temporary investments Receivables Inventories Prepaid and other current assets Total current assets Land Buildings and equipment (net) Total assets Liabilities and Shareholders' Equity Accounts payable Current portion of long-term debt Accrued income taxes Total current liabilities Long-term debt Total liabilities Shareholders' Equity Common stock Retained earnings Total shareholders' equity Total liabilities and shareholders' equity 2018 W 20,630,000 3,220,000 235,000 211,000 110,000 24,456,000 1,904,000 666,400 New 3 90,000 353,000 1,944,000 193,000 2,535,000 260,000 640,000 900,000 W $ 540,000 91,000 93,000 229,000 310,000 1,539,000 225,000 1,121,000 1,946,000 $ 3,435,000 2012' $23,300,000 12,900,000 3,600,000 220,000 200,500 90,000 22,010,500 1,239,500 626,325 M $ 60,000 202,000 1,405,000 113,000 1,235,000 140,000 450,000 590.000 $ 2,325,000 $ 500,000 30,000 39,000 669,000 600.000 1,269,000 624,000 432,000 1,106,000 $ 2,325,000