Costco Wholesale Corporation: Financial Statement Analysis Harvard Case Solution & Analysis

Question 1

How appropriate are the five factors that Torres chooses to determine the future performance of Costco?

            The five factors that had been determined by Torres as important to judge and predict the future performance of the company are the number of the stores, sales per store, the membership fees, the operating margins and the international expansion through stores. Each of these factors is analyzed below:

Number of Stores:The number of the stores in US and the international market are growing at an average growth rate of around 7.97% and 7.58% respectively. This growth rate for the domestic and the international market seems to be assertive and this might not be appropriate in the face of the competitors. SAMs had announced its plans to increase the new store openings aggressively and if Costco does not adopt aggressive growth in its store openings then it might be possible that SAM can create a competitive edge over Costco. Therefore, the management needs to adopt an aggressive growth in the store openings with around 600 stores by the end of the year 2010.

Sales per Store: The sales per store are growing at an approximate growth rate of 2% and this seems to be appropriate given the dynamics of the competition in the market. It might not be possible for the company to reach revenues of $ 150 million per store given the intensity of the competition. The most significant threat for the company would be from Wal-Mart and SAMs.

Membership Base: The third growth driver is the membership base. The growth in the total members is approximately 8% which is appropriate; however, Torres has kept the renewal rate of the members as constant which is not appropriate. As more money would be spent on the merchandise and the value for the customers would increase, therefore, there is high probability that the renewal rate would also increase.

Operating Margins:The operating margin ratios for the company also seem to be appropriate. The approximate gross profit margin for the company would be around 10.5%. The company has high probability of achieving pre-tax margins of around 3.6% over the period of the next 5 years.

International Expansion:The growth of the international stores is approximately 7.58% and this could be considered as assertive and appropriate. The company would be able to open these international stores in the most profitable areas of the world.

Question 2

What other relevant factors might be included in a forecast of the business? To what extent are they covered in the factors above?

            One important factor that should have also been considered by Torres in forecasting the future performance of the company is to estimate the return on equity and the asset turnover ratio for the subsequent years. However, we can see that that average growth rate for the sales of the company is between 8%-10% and the average growth rate for the total assets of the company would be 7% to 9% approximately. Therefore, it could be inferred from this information that the asset turnover for the forecast period is going to be favorable for the company and likely to increase.

            In the similar manner, the return on equity for the company would also improve over the years as the average growth in the net income for the company is 12.39% as compared to the average equity growth of 10.34%. To some extent the asset turnover and the return on equity ratios are covered in the US and international store sales growth sales per store growth and the operating margin ratios.

 Question 3

Review Torres’ assumptions in Exhibit 2. Which assumptions would represent a change from Costco’s historical performance? Do you feel her assumptions are appropriate, and if not, which ones would you change?

            There are numerous assumptions in exhibit 2 that do not seem to be appropriate or in line with the historical performance of the company. First of all, the company assumed the cost of goods sold to remain at a percentage of 89.5% of the total sales for Costco. This is a highly optimistic assumption and the cost of goods sold depends on a number of external factors that are outside of the control of the management. Therefore, the management needs to at least increase its cost of goods sold with the forecasted rate of inflation for all the future years............................

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