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.

	2021	2020
Sales	$26,360,000	$23,800,000
Merchandising Costs	$20,680,000	$17,900,000
Operating, General, & Administrative	$3,220,000	$3,600,000
Rent	$235,000	$220,000
Depreciation and Amortization	$210,000	$200,500
Interest Expense	$110,000	$90,000
Total	$24,455,000	$22,010,500
Earning 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

Required

a. 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?

b. 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.