Case 12.1 Home Value Stores (LO2)

Home Value Stores operates 264 membership warehouse stores in the United States, Europe, andAsia. The company offers low prices on a limited selection of household and grocery products.In the past year, sales increased by approximately 10.8 percent and net earnings increased by6.4 percent. The company opened only two stores in 2020 and 2021 and closed one of its stores dueto poor performance. Jack Davidson and Michael Prine are on the board of directors of Home Valueand serve on the company's compensation committee. At a recent lunch meeting, they discussedthe company's performance. (See the table on the next page for a balance sheet and an incomestatement.) Both were pleased with the increase in profit and decided to recommend a contractextension and a substantial six-figure bonus for the company's CEO. They anticipated, 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. Shehas also pointed out that, although the company showed quarterly profit increases, its stock priceremained flat.

Required

a. To prepare for an upcoming board meeting, Tanya has asked you to evaluate financial performancefor 2020 and 2021, 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 amountrequired given the investment in the company. Assume that the cost of capital is 15 percent. Is itclear that the company has had superior financial performance?

b. In fiscal 2022, the CEO of Home Value Stores retired. His successor is concerned that warehousemanagers do not understand how their actions are linked to the company's strategy and how theycan affect future firm value. In his opinion, while monthly earnings are important, managers arefocused 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) 2021 2020 Sales $26,360,000 $23,800,000 Merchandise costs 20,680,000 17,900,000 Operating, general and administrative 3,220,000 3,600,000 Rent 235,000 220,000 Depreciation and amortization 211,000 200,500 Interest expense 110,000 90,000 Total 24,456,000 22,010,500 Earnings before taxes 1,904,000 1,789,500 Taxes 380,800 357,900 Net earnings $ 1,523,200 $ 1,431,600 Assets Cash and temporary investments $ 90,000 $ 60,000 Receivables 358,000 202,000 Inventories 1,944,000 1,405,000 Prepaid and other current assets 193,000 118,000 Total current assets 2,585,000 1,785,000 Land 260,000 140,000 Buildings and equipment (net) 640,000 450,000 900,000 590,000 Total assets $ 3,485,000 $ 2,375,000 Liabilities and Shareholders' Equity Accounts payable $ 540,000 $ 500,000 Current portion of long-term debt 91,000 80,000 Accrued income taxes 98,000 89,000 Total current liabilities 729,000 669,000 Long-term debt 810,000 600,000 Total liabilities 1,539,000 1,269,000 Shareholders' Equity Common stock 775,000 674,000 Retained earnings 1,171,000 432,000 Total shareholders' equity 1,946,000 1,106,000 Total liabilities and shareholders' equity $ 3,485,000 $ 2,375,000