Abc Learning

Question 1)

(a)

Throughout FY08 to FY11, David Jones (DJs) announced the establishment of six new stores in high value demographics around Australia over several years; the investment is a key component of DJs '3 point' strategy and aims to grow revenue through increasing network of stores and foot traffic. Details of the stores, estimated sales and Earnings Before Interest & Tax (EBIT) contributions is in the table below and share price impact of the announcements:

Shareholder value relating to the new stores is fundamentally about generating positive returns from the stores; with focus on medium to long term growth in operating cash flows (versus maximising current/next year profits). As the stores are not constructed they have not yet driven shareholder value as at 30 June 2012. This is supported by the minimal movement in share price between the closing price of the day new store was announced and the closing price the day before.

The table and chart below highlights the Market Value Added (MVA) for DJs from FY08 (first of the new stores announced) to FY11 (latest balance date). As MVA is decreasing from FY09 to FY11, highlights that DJs is destroying shareholder wealth, driven by decreasing market capitalisation. A way in which DJs could improve the MVA is if market capitalisation increased (issuing more shares) or reducing the level of capital employed in the business.

When investing in new stores, DJs have a minimum benchmark sales of $40m per annum and EBIT of $5m per annum by year two of opening- thus new stores only committed when they can be shown to deliver positive cash flows . As all of the six new stores announced all meet or exceed the benchmark, if the forecasts are realised then in the long term long term this will lead to higher cash level (all else being equal). Thus the new stores will add to long term shareholder value and provide financial returns to shareholders through additional capacity, sales and EBIT.

The fundamental question is whether the stores will generate enough incremental sales and EBIT. Given the long term nature of the strategy to expand new stores, and that the stores are in high demographic areas, reducing significantly the risk that the new stores will not generate the forecast sales and EBIT, we believe this is a viable long term strategy in adding shareholder value, at this point in time.

In relation to DJs decision to investment in six new stores there are several financial management issues that need to be addressed in order for the investment to be deemed successful. These issues include prudent use of capital, sources and structure of funding, impact on balance sheet (e.g., working capital), cash flows and on dividend policy.

The first issue to consider is whether the returns from this investment decision will outweigh the costs of the investment.