Case 11-4 Enager Industries, Inc. 1. Why was McNeils new product proposal rejected? Should it have been?

Explain.

ROA CALCULATION FOR EACH NEW PRODUCT Product A Product B Unit Sales 100,000 75,000 Unit Price 18 21 Total Sales $1,800,000 $1,575,000 Variable Cost per Unit Variable Costs Fixed Costs Net Income Total Asset Investment Return on Assets 9 900,000 510,000 $390,000 $3,000,000 13.00% 9 675,000 510,000 $390,000 $3,000,000 13.00%

Product C 60,000 24 $1,440,000 9 540,000 510,000 $390,000 $3,000,000 13.00%

The McNeils new product proposal was rejected because it shows a return on assets less than the required by the president of 15%. McNeils proposal should have been accepted because: The ROA for the new product is higher than the current ROA for the Consumers Divisions of 10.8% 13% is higher than the current ROA of the company as a whole (9.4%). It is higher than the hypothetical 12% ROA set by Hubbard that covers interest costs of borrowing capital. If EVA is calculated instead, the residual income is positive. EVA = Net Income (Cost of Capital x Investment) = 390,000 (12% x 3,000,000) = 30,000

2. What inferences do you draw from a cash flow statement for 1993? Is a breakdown by divisions useful? Would a cash flow statement be useful in evaluating performance? If you had
one that showed a breakdown by division, how would you use it?".

A cash flow statement helps to evaluate performance because: It determines the ability of the company and each division to generate cash flows from operations. Cash is king for some analysts. We could see how is the cash for investments being allocated. How is the company financing their new capital expenditures, stocks or debt. A breakdown by division is very useful because: An analysis of the performance of each division is possible. Cash generated by division is a better metric of operational efficiency.

I would use cash flow statements by divisions to: Determine if cash flows backup the current measurement of ROA. Find out which division is investing in new equipment and how. Compare each other division cash flows. As I mention later, I dont think Professional Services is being fairly compare with the other two divisions.

3. What inferences do you draw from the comparative balance sheets and income statements for 1992 and 1993? Analyzing the comparative income statements, the following conclusions are drawn: Sales went up 4.93% from last year. Cost of Goods Sold rose by a smaller percentage than sales, 3.97% Net income increased 11.45% from 1992 to 1993. Gross margin ratio for 1992 was 23.50% and for 1993, 24.21%.; a positive increase of 0.71%. Other expenses saw a spike of 6.43%. 56% of the increase belongs to Interest. Increase in interest expense is tied to increase in current and long-term debt in the Balance Sheet. Conclusion: Enager had a improvement of net income year to year due to an increase in sales, cost cutting measures and contained expenses. Analyzing the comparative balance sheet statements, the following conclusions are drawn:
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Total Assets went up considerably: 17.78%; Inventories: 14.91%; P&E: 20.79% 14.01% more credit sales were issued. Total liabilities increased from 1992: 30.22%.; current liabilities: 36.92%; Long-term debt: 22.39%. Financial ratios: Current Ratio Debt-to-equity ratio Working capital Working capital/Total Assets Return on Assets Return on Sales Return on Equity 1992 3.41 0.59 78,972 0.41 5.7% 5.1% 9.1% 1993 2.84 0.69 82,734 0.37 5.4% 5.5% 9.2%

Conclusion: There was a considerable investment in plant and equipment that was largely financed by long-term debt and possibly stocks. This investment did not produce the expected return since ROA actually decrease by 0.1%. Maybe Enager was unable to sell some of its products because of the increase in inventory. In terms of ratios, the company increased its working capital. ROE and ROS saw a slight raise, but current ratio and debt-to-equity ratios decreased because of the aforementioned increase in debt.

4. Evaluate the manner in which Randall and Hubbard have implemented their investment center concept. What pitfalls did they apparently not anticipate? Evaluation of Enagers Investment Center Concept: Strengths: Able to relate each divisions profit to the the assets the division used to generate its profits. Easy application and understanding: the sum of the divisional parts equal the corporate whole. Clear goals: each division should exceed the companys gross return of 12%. New investment should bring 15% return to be approved.
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Weaknesses: Comparing apples and oranges. Each investment center has different nature of activities and is in a different business cycle. For example, Consumer Products is in a mature market while Professional Services is in an emerging market. Total sales are equally divided by division. More useful would be to see how much each division is actually selling. Comparing investment centers ROA using depreciable assets is tricky. Industrial division could have a higher ROA (as mentioned) if their equipment was older (lower book value). Professional services should not be operating as an investment center. The manager does not make decisions regarding fixed assets. On the other hand, human capital (the people doing the services) is their main asset. The allocation method used for corporate assets skews the results in favor of professional services division. Since professional services has less earnings, their allocation of assets is lower. Profitable projects are being rejected because their ROA is lower than 15%.

5. What, if anything, should Randall do now about his investment center approach? Recommendations: Sales should be reported by division not allocated. Change the current allocation of corporate-office assets to a system that more accurately measures the actual use of administrative expenses by each division. Run Professional services division as a profit center. Calculate ROA using book value of assets when comparing Consumer and Industrial Products divisions. This will stop the current distortion and prevent that managers start keeping old equipment around for the sole purpose of increasing their ROA. Use EVA, in addition to ROA, to evaluate the approval of new products/projects. When calculating EVA, allocate different cost of capital for each division to take in account the different natures of their businesses.

6. Design a balanced scorecard for Consumer, Industrial, and Professional Products Divisions of Enager Industries. Be specific for each division. CONSUMER PRODUCTS DIVISION Objectives Increase sales Improve ROA Improve asset utilization Measures Revenue growth ROA Cash Flow EVA Profit Margin Market share Product returns Warranty claims Inventory levels Manufacturing time Product returns New product ROI Employee satisfaction surveys Employee turnover rate Targets >12% Initiatives Asset Disposition Program New innovative products.

Financial

Customer

Increase customer satisfaction Increase customer loyalty

Up 5% Down 10% Down 20% By 10%

Customer surveys

Internal Processes

Improve manufacturing of products Operational excellence Quality assurance Reduce inventory Maintain employee morale Promote innovation Adequate training of personnel

Measure how many product returns are tied to quality and how many to functionality. Reward innovation and creativity. Houseware segment needs differentiating products to break through stagnant numbers.

Learning & Growth

80%

INDUSTRIAL PRODUCTS DIVISION Objectives Increase sales Improve ROA Improve asset utilization Reduce costs Measures Revenue growth ROA Cash Flow EVA Profit Margin Customer complaints Product returns On time delivery Manufacturing time Utilization rates Targets Up 5% Initiatives Monitor that new investments in plant and equipment are producing an adequate return. Find new ways to reduce costs of customization. Since the division is involved with a customer for a couple of months, keep customer informed during this time. New equipment requirements should be tie into sales growth. Is the new equipment mostly utilized?

Financial

Customer

Customized products Improve customer communication Increase customer satisfaction Increase customer loyalty Reduce manufacturing time Operational excellence Quality assurance Equipment/Job trade-offs

Down 15%

Down 10%

Internal Processes

Maintain employee morale Training of personnel Account executives workshops Encourage new ideas of cost cutting measures.

Learning & Growth

Employee 80% satisfaction surveys Employee turnover rate

Account executives should be trained to educate the client on the trade-offs of customization and costs.

PROFESSIONAL SERVICES DIVISION Financial Objectives Increase revenues Reduce overhead expenses. Measures Revenue growth Cash Flow Profit Margin Targets Up 10% Initiatives Increase accounts by retaining current customers and increasing referrals. Accuracy and prompt delivery of reports are closely tied to customer satisfaction and repeat customers. Close scrutiny of billable hours. Is the time spent efficiently?

Customer

Increase customer base. Increase customer satisfaction Increase customer loyalty

Customer feedback On time delivery of Up 15% services Market share Percentage of on time delivery Sales/Billable hours Up 20%

Build the division Increase revenues relative to billable hours. Best in class On time delivery of reports Keep up to date with new laws and regulations Develop employee knowledge Maintain employee morale

Internal Processes

Employee 80% satisfaction surveys Employee turnover rate Competency tests

Send personnel to workshops and seminars discussing new regulations. Compensation program based on performance.

Learning & Growth

7. What other advice do you have for Randall and Hubbard? Review credit policy and determine the current collectability of receivables. Improve inventory management and forecast procedures. Establish a ceiling for plant and equipment purchases. Require ROA for approval of new equipment purchases. Use EVA for the approval of new projects. Consider reducing the required 15% ROA. More than 12% ROA is enough to cover the cost of debt. Implement the proposed balanced scorecards.