The company offers low prices on a limited selection of household arid grocery products. In the past year, sales increased by approximately 8.5 percent and net earnings increased by 12 percent. The company opened only two stores in 2011 and 2012 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 table on the right 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:
a. To prepare for an upcoming board meeting, Tanya has asked you to evaluate financial performance for 2011 and 2012, 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 12 percent. Is it clear that the company has had superior financial performance?
b. In fiscal 2013, 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.
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