Case 12.1 Home Value Stores (LO2)

Home Value Stores operates 264 membership warehouse stores in the United States, Europe, and Asia. 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 by 6.4 percent. The company opened only two stores in 2020 and 2021 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 committee. 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 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. She has also pointed out that, although the company showed quarterly profit increases, its stock price remained flat.

Required

To prepare for an upcoming board meeting, Tanya has asked you to evaluate financial performance for 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 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?

In fiscal 2022, 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)

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 liabilities1,539,0001,269,000

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