Management compensation These days most of the businesses are run by professional managers who are part of management

team. This leads to

separation of ownership and control which leads to conflict between shareholders and managers. These professional managers are paid additional
incentives apart from regular monthly salaries. With better company's performance and growth of business managers are paidh inhcentivhes ash
compensathion or chrediting them fhor company's performhanceh.

Shareholder will be woried if the roiis unable to cover the cost of capital.

High initial costs incurred to set up the new stores e.g. hiring more staff, inventory purchases and capital

expenditure

? Costs will flow down to the net income and reduce the distributable income to

shareholders

? More fixed capital is tied to the new stores - more risk borne by the shareholders

? Debt payer have claims before shareholders in the event when company

become insolvent ? Higher debt ? Higher risk ? Higher IR

? reduce distributable income to shareholders

Cannibalization of sales

(ROI)

? No stores will operate at potential level

? Revenue may increase but same store sales is likely to decrease

Branding Issues (ROI)

? Additional staffing is needed with more outlets

? Integration of new employees can take time

? Mismanagement of employees may cause company's branding to be tarnished

? E.g. Bad customer services may lead to lost sales, deviation from core principle

1.2

? Avoid violation of debt covenants

? E.g. a loan agreement may use the firm’s

EBITDA as an affirmative covenant to ensure the borrower’s ability to repay the lender (e.g. minimum EBITDA)

? Manager might just focus on their target bonus and manipulate their definition of

EBITDA without taking into consideration of debt covenan

What if debt covenant was breached?

? A penalty or fee charged

? An increase in the interest rate of the bond or loan;

? An increase in the collateral;

? Termination of the debt agreement; demanding payment in full

Revenue = $50m
20% of Revenue = $10m
EBITDA = $20m
80% of EBITDA = $16m
Target payout for Revenue = 70%
Target payout for EBITDA = 85% (Pro-rated)

Total Payout = (10 x 70%) + (24 x 85%) = $27.4m

70% 100% 140%

EBITDA 10 Million 30 Million 60 Million

 Revenue 50 Million 100 Million 150 Million

% Target Payout
Threshold 70%
Target 100%
Maximum 140%

Measure of profits and mainly used to compare the financial heal the of a
EBITDA

company, without taking into consideration its capital structure, taxes or different
depreciation and amortization assumptions a company may have.
Lower/avoid operating expenses to increase EBITDA

 Delay critics research or expenses for repair and maintenance

 Capitalize certain expenses as assets

 Subject to IAS 18 and FRS 116

 Decrease provisions

Potential acceleration of earnings during bad years and recording less revenue during good years

Manipulating Inventory Valuation

(COGS)

COGS Ending Inventory

LIFO Highest Lowest

FIFO Lowest Highest

 Prefer FIFO since the resulting COGS is lower, which will cause a higher EBITDA

Increase in Debt and LiabilitiesH

• Debt fell from $25,743 to $1,993

• Interest expenses will be lower

• Since pre-tax income considers interest expenses, a fall in interest expense will be favourable to the management

6-1

1. Which company has shown the strongest sales growth over the past three years?
Based of the information provided in the table above it is safe to assume that Kroger co. has shown the strongest sales growth over the past three years
because of the of a more positive annual sales

growth rate.

2. Which company was the most profitable in its most recent fiscal year? – What was the source of that superior profitability—a profit margin advantage or
better turnover?

With the average ROA taken into account for the 3 companies, it can be concluded with the information provided that Kroger co. had the most average
growth from year one.

1.Current Ration i.e (Current Assets/ Current Liabilities) reflected the liquidity of the organizations.

Cash conversion cycle presents the time needed for the organization in between procurement of raw material and receiving the moneys
from its buyer.

Since Ross store has the least current ration i.e. 1.36, we might say that it owns least liquid assets at present.
but the ratio is above 1 then we might say that the organization owns enough current assets to satisfy its current obligation. To support
the same quick ratio analysis is required.

2. Occupancy Cost includes costs related to occupying a space including; rent, real estate taxes, personal property taxes, insurance on
building and contents, depreciation, and amortization expenses.
if the same related to cost of goods sold included in Cost of Goods sold then more weightage would be assigned to the Days inventory
held, as an additional day will be costly to the organization.

3. Ross store's 2.2 days accounts receivable outstanding is result of its practice of selling goods on credit.

4.Aerostale & the GAP having 0 day accounts receivable is result of its policy of only cash sale.
1. Return on Assets (ROA) = net income/Average total assets

For 2016:

For 2017: Net income = $900.4 million

Average total assets = ($14,327 + $15,223.5)/2

= $14,775.25 million

ROA = $900.4 million/$14,775.25 million

= 6.1%

For 2017:

Net income = $1,380.6

Average total assets = ($15,223.5 + $15,841.3)/2

 = $15,532.4million

ROA = $1,380.6 million/$15,532.4 million

= 8.9%

For 2018:

Net income = $2,481.1

Average total assets = ($15,841.3 + $17,920.6)/2

= $16,880.95 million

ROA = $2,481.1million/$16,880.95 million

= 14.7%
2. Return on Assets = Net profit margin*Asset turnover ratio

Net profit margin = net profit/net sales revenue

Asset turnover ratio = net sales revenue/average total assets

For 2016:

Net profit margin = $900.4 million/$16,208.1 million

= 5.56%

Asset turnover ratio = $16,208.1 million/$15,223.5 million

= 1.065
ROA = 0.0556*1.065

= 5.92%

For 2017:

Net profit margin = $1,380.6 million/$20,252.4 million

= 6.82%

Asset turnover ratio = $20,252.4 million/$15,841.3 million

= 1.28

ROA = 0.0682*1.28

= 8.73%
For 2018:

Net profit margin = $2,481.1 million/$25,067.3million

= 9.9%

Asset turnover ratio = $25,067.3 million/$17,920.6 million

= 1.40

ROA = 0.099*1.4

= 13.86

3. Yes, the profitability has changed over the three years. In 2016, the net profit margin was

. 5.56%, which increased to 6.82%. In 2018, the net profit margin came to be 9.9%. The profitability has shown an increasing trend over the three years.
4. Return on Equity (ROE) = Net income/Average Equity

For 2016:

Net income = $900.4 million

Average equity = ($7,849.9 + $8,254.7)/2

= $8,052.3 million

ROE = $900.4 million/$8,052.3 million

= 11.182%

For 2017:

Net income = $1,380.6

Average total equity= ($8,254.7 + $9,084.8)/2

= $8,669.75 million
ROE = $1,380.6 million/$8,669.75 million

= $15.92%

For 2018:

Net income = $2,481.1

Average equity = ($9,084.8+ $10,202.0)/2

= $9,643.4 million

ROE = $2,481.1million/$9,643.4 million

= 25.73%
Question 1: Do any of these companies appear to have a short-term liquidity problem?

Short term liquidity can be shown using the current ratio: current ratio =

current assets / current liabilities

Since all companies have a current ratio greater than 1, they have more current assets
than current liabilities and therefore do not have a short- term liquidity issue.
Question 2: How does the industry practice of including occupancy costs in cost
of goods sold affect the statistics presented in the table.

Occupancy costs are costs related to occupying a space including rent, real
estate taxes, personal property taxes, insurance on buildings, deprecation
expense, and amortization costs.
Including these costs in COGS for the inventory can raise the price of the
items and lengthen the amount of time the company holds the inventory
(DaysInventoryHeld). This then
affects the Operating Cycle and Cash Conversion Cycle by making
themlonger.
Question 3: What is the most likely explanation for Ross Stores’s 2.1 days
accounts receivable outstanding?

This likely shows that Ross is handling days of credit for certain
customers. When looking at the other companies, GAP appears to not
practice this due to the company having zero days accounts
receivable outstanding. American Eagle Outfitters might do this more
often because it has 7.9.
Question 1

Question 4: What is the most likely explanation for 0.0 days

accounts receivable outstanding at The GAP?

It is likely that they only work in cash sales.

Opening new stores does not guarantee that the new

stores that were opened will be successful. Their
Question 2

expenses could be higher than their income and will lead

to an overall loss in the long run.
 Question 3

It is important because it does not allow managers that will greatly

benefit from the bonus plan to be able to alter any information that
will profit the changes that were made. Having the same system can
deter managers from violating the loan agreement
 Question 3

The managers could minimize expenses and maximize the profits to

make sure they make the required numbers to receive their bonus.
Their debt significantly decreased between the years 2013 and 2014.