Case 22-4 Enager Industries Our Analysis
Case 22-4 Enager Industries Our Analysis
Case 22-4 Enager Industries Our Analysis
Case Background
Enager Industries, Inc. was a relatively young company whom manufactured and produced
products/services within three divisions- Consumer Products, Industrial Products and Professional
Services. Consumer Products, the oldest among the three divisions in Enager, designed, manufactured and
marketed a line of houseware items. Industrial Products built one of a kind machine tools to customer
specifications. Professional Services, the newest among the three, provided several kinds of engineering
services and this division had grown rapidly because of its capability to perform environmental impact
studies . At the urging of CFO Henry Hubbard, Enagers President, Carl Randall, had decided to begin
treating each division as an investment center, so as to be able to relate each divisions profit to the assets
the division used to generate it profits. However, several issues arose regarding this performance
evaluation method and other management control choices. First of all, profitable new project at Consumer
Products Division, whose return was 13% calculated from Exhibit 3, could not get approved from upper
management because it could not reach the pre-determined universal target return of at least 15 percent,
even if all the divisions had completely different line of business. This could potentially discourage
product development managers incentive to engage in new projects. More importantly, the company
could miss out the opportunity on new products in the long-run, although it might not have a large return
right away in the short-run.
Secondly, the president of the company, Carl Randall, was both puzzled and disappointed at the
discrepancies among the performance evaluation parameters of the company in 1997. Both ROA and
gross return dropped from 1996, while return on sales and return on owners equity increased. There were
also discrepancies across different divisions, as Professional Service easily exceeded the 12% gross return
target; while other two divisions, especially the Industrial Product division had a ROA that was only
6.9%. These discrepancies could increase the difficulties for the top management to understand the
performance, thus hindered managers ability to make good decisions.
1996
$70,731
54,109
16,622
1997
$74,225
56,257
17,968
4,032
6,507
994
11,533
4,008
6,846
1,376
12,230
5,089
2,036
$3,053
5,738
2,295
$ 3,443
$6.11
$6.26
Exhibit 2
ENAGER INDUSTRIES, INC.
Balance Sheets
For 1996 and 1997
(thousands of dollars)
As of December 31
1996
1997
Assets
Current assets:
Cash and temporary investments..........................................................
Accounts receivable.............................................................................
Inventories...........................................................................................
Total current assets........................................................................
Plant and equipment:
Original cost.........................................................................................
Accumulated depreciation....................................................................
Net.......................................................................................................
Investments and other assets....................................................................
$ 1,404
13,688
22,162
37,254
$ 1,469
15,607
25,467
42,543
37,326
12,691
24,635
2,143
45,736
15,979
29,757
3,119
$75,419
$ 9,720
1,210
-10,930
559
12,622
24,111
17,368
22,553
39,921
$12,286
1,045
1,634
14,965
985
15,448
31,398
19,512
24,509
44,021
$75,419
Exhibit 3
4.3%
23.5%
5.7%
9.2%
1.4%
1.10
3.41
1.38
7.9
70.6
149.5
9.5%
6.9%
7.6%
4.8%
24.0%
1997
4.6%
24.2%
5.4%
9.2%
1.9%
0.98
2.84
1.14
7.9
76.7
165.2
9.4%
7.0%
7.8%
4.6%
28.0%
Ratio based on year-end balance sheet amount, not annual average amount.
Invested capital includes current portion of long-term debt, excludes deferred taxes.
Adjusted for interest expense add-back.
Not adjusted for add-back of interest; if adjusted, 1996 and 1997 ROA are both 5.7 percent.
Exhibit 4
FINANCIAL DATA FROM NEW PRODUCT PROPOSAL
1. Projected asset investement:1
Cash....................................................................................................................
Accounts receivable............................................................................................
Inventories..........................................................................................................
Plant and equipment2..........................................................................................
Total.............................................................................................................
$ 50,000
150,000
300,000
500,000
$1,000,000
2. Cost data:
Variable cost per unit..........................................................................................
Differential fixed costs (per year)3......................................................................
$3.00
$170,000
Break-even Volume
56,667 units
42,500
34,000
Areas of Considerations
A management control system is a means of gathering and using information to aid and coordinate the
planning and control decisions throughout an organization and to guide the behavior of its managers and
employees. The goal of the system is to improve the collective decisions within an organization.
To be effective, management control systems should be (a) closely aligned to an organization's strategies
and goals, (b) designed to fit the organization's structure and the decision-making responsibility of
individual managers, and (c) able to motivate managers and employees to put in effort to attain selected
goals desired by top management.
The Three divisions to consider: Consumer Products, Industrial Products and Professional Services.
Consumer Products, the oldest among the three divisions in Enager, designed, manufactured and
marketed a line of houseware items. Industrial Products built one of a kind machine tools to customer
specifications. Professional Services, the newest among the three, provided several kinds of engineering
services.
Answers to Guide Questions
Question 1. Why was McNeil's new product proposal rejected? Should it have been? Explain.
Mc Neils proposal was rejected because it did not meet the 15% return required by Hubbard. So
Enager Industries Inc., had missed the opportunity to increase its earnings per share of the
company due to incorrectly setting a target rate for all three divisions.
PARTICULARS
PRODUCT A
PRODUCT B
PRODUCT C
100,000
$18
1,800,000
$9
900,000
510,000
1,410,000
390,000
3,000,000
13%
75,000
$21
1,575,000
$9
675,000
510,000
1,185,000
390,000
3,000,000
13%
60,000
$24
1,440,000
$9
540,000
510,000
1,050,000
390,000
3,000,000
13%
Question 2. Evaluate the manner in which Randall and Hubbard have implemented their investment
center concept. The pitfalls did they apparently not anticipate.
The conclusions draw in the cash flaw statements of 1997.
DIVISION
SALES
EBIT
W/C
FIXED
ALLOC
TOTAL
Consumer
Industrial
Professional
service
Total
74.3
74.2
74.2
10.8
7.2
3.3
60.8
44.4
18
34.6
54.6
0.0
4.6
4.6
4.6
100.0
103.6
22.6
GROSS
ROA
10.8
6.9
14.6
21.3
123.2
89.2
13.8
226.2
9.4
The professional services division exceeded the 12% gross return target but the other two
divisions failed to do so.
Consumer division could have underemployed the assets in order to boost the gross ROA.
Cost of goods sold and the other expenses of industrial division in comparison to consumers
division could be high due to which its EBIT has fallen down.
These conclusions help us in performing a root cause analysis of the performance of each division.
Comparative Balance Sheets and Income Statements for 1996 and 1997.
ROA
Gross ROA
ROS
ROE
1996
1997
Inference
5.67%
9.49%
5.13%
4.69%
5.37%
9.43%
5.45%
4.74%
Formulas:
ROA : (Net income) / (Total asset base)
Gross ROA: (EBIT) / (Total asset base)
ROS: (Net income) / (Total sales)
ROE: (Net income) / (Total Equity)
Difficult to compare profit performance unless assets employed is taken into account.
Decisions that increase a centres ROI may decrease its overall profits.
Question 3. What, if anything, should Randall do now with regard to his investment center
measurement approach?
In regard with the investment center measurement approach:
Randall and Hubbard must use Economic Value Added (EVA) for measuring and
controlling the assets employed.
EVA = Capital employed * (ROI Cost of Capital)
Advantages of EVA:
All business units have same profit objective for comparable investments.