Question

In the introduction to this chapter, we described the situation faced by The Gap, Inc. (GPS). We learned that the retail clothing chain had grown dramatically over the first two decades of its existence but had fallen on difficult times in 2007. Assume that you have been hired as a new management trainee by the corporate offices of Gap in the spring of 2009 and that you report directly to the director of sales and marketing. Although your job is not specifically in finance, your boss is a major contributor to the firm’s overall financial success and wants you to familiarize yourself with the firm’s recent financial performance. Specifically, she has asked that you review the following income statements for the years 2005–2008. You are to review the firm’s revenue, gross profit, operating income, and net income trends over these four years.

Gap, Inc.
Income Statements (US$ millions, except per share data), 2005–2008

	2008	2007	2006	2005
Total revenues	$15,763	$15,923	$16,019	$16,267
Cost of goods sold	10,071	10,266	10,145	9,886
Gross profit	$ 5,692	$ 5,657	$ 5,874	$ 6,381
Total operating expense	4,377	4,432	4,099	4,402
Net operating income	$ 1,315	$ 1,225	$ 1,775	$ 1,979
Interest income (expense)	91	90	48	(108)
Earnings before taxes	$ 1,406	$ 1,315	$ 1,823	$ 1,871
Income taxes	539	506	692	721
Net income	$ 867	$ 809	$ 1,131	$ 1,150

After contemplating the assignment, you decide to calculate the gross profit margin, operating profit margin, and net profit margin for each of these years. It is your hope that by evaluating these profit margins you will be able to pinpoint any problems that the firm may be experiencing.

Finally, your boss points out that the firm may need to raise additional capital in the near future and suggests that you review the firm’s past financing decisions using both the firm’s balance sheets and its statements of cash flows. Specifically, she asks that you summarize your assessment of the firm’s use of debt financing over these four years.

Gap, Inc.
Balance Sheets (US$ millions, except per share data), 2005–2008

	2008	2007	2006	2005
Cash and short-term investments	1,901.00	2,600.00	2,987.00	3,062.00
Inventory	1,575.00	1,796.00	1,696.00	1,814.00
Other current assets	610.00	633.00	556.00	1,428.00
Total current assets	4,086.00	5,029.00	5,239.00	6,304.00
Gross plant and equipment	7,320.00	7,135.00	6,958.00	7,169.00
Other long-term assets	485.00	318.00	336.00	368.00
Total assets	7,838.00	8,544.00	8,821.00	10,048.00
Accounts payable	1,006.00	772.00	1,132.00	1,240.00
Accrued expenses	1,259.00	1,159.00	725.00	924.00
Notes payable/short-term debt	0.00	0.00	0.00	0.00
Current portion of long-term debt and leases	138.00	325.00	0.00	0.00
Other current liabilities	30.00	16.00	85.00	78.00
Total current liabilities	2,433.00	2,272.00	1,942.00	2,242.00
Long-term debt	50.00	188.00	513.00	1,886.00
Other liabilities	1,081.00	910.00	941.00	984.00
Total liabilities	3,564.00	3,370.00	3,396.00	5,112.00
Common stock	55.00	55.00	54.00	49.00
Additional paid-in capital	2,783.00	2,631.00	2,402.00	904.00
Retained earnings (accumulated deficit)	9,223.00	8,646.00	8,133.00	7,181.00
Treasury stock—common	(7,912.00)	(6,225.00)	(5,210.00)	(3,238.00)
Other equity	125.00	77.00	46.00	40.00
Total stockholders’ equity	4,274.00	5,174.00	5,425.00	4,936.00
Total liabilities and stockholders’ equity	7,838.00	8,544.00	8,821.00	10,048.00

Legend:

Treasury stock —shares of a firm’s common stock that had previously been issued to the public but that have been repurchased in the equity market by the firm.

Gap, Inc.
Statements of Cash Flows (US$ millions, except per share data), 2006–2008

	2008	2007	2006
Net income	$   833	$  778	$  1,113
Depreciation	547	530	625
Deferred taxes	(51)	(41)	(46)
Noncash items	107	67	(28)
Changes in working capital	645	(84)	(113)
Cash flow from operating activities	$   2,081	$ 1,250	$  1,551
Capital expenditures	(682)	(572)	(600)
Other investing cash flow items, total	408	422	886
Cash flow from investing activities	$ (274)	$ (150)	$   286
Financing cash flow items	132	213	0
Total cash dividends paid	(252)	(265)	(179)
Issuance (retirement) of stock, net	(1,700)	(1,050)	(1,861)
Issuance (retirement) of debt, net	(326)	0	0
Cash flow from financing activities	$(2,146)	$(1,102)	$(2,040)
Foreign exchange effects	33	(3)	(7)
Net change in cash	$ (306)	$   (5)	(210)

Answer 1