Case 22-4 Enager Industries, Inc

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.

The following are the exhibits of the case:

Exhibit 1
ENAGER INDUSTRIES, INC.
Income Statement
For 1996 and 1997
(thousands of dollars, except earnings per share figures
Year Ended December 31
Sales.........................................................................................................
Cost of sales.............................................................................................
Gross margin............................................................................................
Other expenses:
Development......................................................................................
Selling and general.............................................................................
Interest...............................................................................................
Total..............................................................................................

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

Income before taxes.................................................................................

Income tax expense..................................................................................
Net income...............................................................................................
Earnings per share (500,000 and 550,000 shares outstanding in 1996 and
1997, respectively)...................................................................................

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

Total assets............................................................................................... $64,032

$75,419

Liabilities and Owners Equity

Current liabilities:
Accounts payable.................................................................................
Taxes payable......................................................................................
Current portion of long-term debt........................................................
Total current liabilities...................................................................
Deferred income taxes..............................................................................
Long-term debt.........................................................................................
Total liabilities...............................................................................
Common stock
Retained earnings.....................................................................................
Total owners equity......................................................................

$ 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

Total liabilities and owners equity.......................................................... $64,032

$75,419

Exhibit 3

RATIO ANALYSIS FOR 1996 AND 1997

1996
Net income Sales...................................................................................
Gross margin Sales................................................................................
Development expenses Sales.................................................................
Selling and general Sales.......................................................................
Interest Sales.........................................................................................
Asset turnover1.........................................................................................
Current ratio.............................................................................................
Quick ratio................................................................................................
Days cash1...............................................................................................
Days receivables1....................................................................................
Days inventories1....................................................................................
EBIT Assets1.........................................................................................
Return on invested capital1,2,3....................................................................
Return on owners equity1........................................................................
Net income Assets1,4..............................................................................
Debt/capitalization1..................................................................................
1.
2.
3.
4.

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

3. Price/market estimates (per year):

Unit Price
Unit Sales
$6.00
100,000 units
7.00
75,000
8.00
60,000
1.
2.
3.

Assumes 100,000 units sales.

Annual capacity of 120,000 units.
Includes straight-line depreciation on new plant and equipment.

Break-even Volume
56,667 units
42,500
34,000

Statement of the Problem

The problem occurred when the president was unsatisfied with the ROA (Return of Assets) of Industrial
Products Division and tried to put pressure on the General Manager of the Division.

To develop and understanding of process and systems for management control

To discuss the nature of Management control process
To elaborate how accounting information facilitates management control
To be familiarize with the concept of responsibility centers and their utility and application in
management control

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

No. of units sold

S.P. per unit
Total sales($)
Variable cost per unit
Total variable cost
Total fixed cost
Cost of goods sold($)
Net income
Total asset base($)
Return from proposal*

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%

* return = net income / total asset base

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%

More assets employed in 97 to boost sales

More assets employed in 97 to boost sales
More income earned in 97 due to boost in sales
ROE has improved which is of great importance for the stakeholders.

Formulas:
ROA : (Net income) / (Total asset base)
Gross ROA: (EBIT) / (Total asset base)
ROS: (Net income) / (Total sales)
ROE: (Net income) / (Total Equity)

A shift from profit centre concept to investment centre concept because:

Comparing absolute differences in profit is not meaningful.

Difficult to compare profit performance unless assets employed is taken into account.

Business unit managers have 2 performance objectives:

1. To generate profits from resources used.
2. To invest in additional resources only if it produces an adequate return.
3.
Hubbard and Randall used ROI to measure the assets employed.
The Pitfalls
ROI provides different incentives for investments across business units.

 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.

Different interest rates may be used for different types of assets.

It has a stronger positive correlation with changes in companys market value.

Conclusion and Recommendation

Enager Industries Inc., was a relatively young company which had grown rapidly to its 1997 sales level of
over $74 M (Exhibit 1-3). The company was using ROA as method of performance evaluation of the
three divisions, which is inefficient since the total divisional assets and net income are influenced by
varying components.
We would like to recommend that Enager Industries Inc., should implement a Balance Scorecard method
for their divisions performance measures. We feel that ROA reduces the comparability between divisions,
limits expansions for the company and individual divisions and consequently it does not provide fair
performance measurements for the three divisions and the company.
This suggest that ROA does not fully depict the performance of the company. Balance Scorecard on the
other hand, it is a better method for Enager for assessing divisional performance because it effectively
depicts performance from non-performance perspectives. It promotes goal congruence because divisions
will not only be working to better themselves, but also the decisions that are made will benefit as a whole.
Balanced Scorecards tell you the knowledge, skills and systems that your employees will need (learning
and growth) to innovate and build the right strategic capabilities and efficiencies (internal processes) that
deliver specific value to the market (customer) which will eventually lead to higher shareholder value
(financial).