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 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 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.

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.