CASE ENAGER INDUSTRIES

“I didn't get it. I’ve got a nifty new product proposal that can’t help but make money, and
top management turns thumbs down. No matter how we price that new item, we expect to
make $390,000 on it pretax. That would contribute over 15 cents per share to our
earnings after taxes, which is more than the 10 cent earnings per-share increase in 2014
that the president make such a big thing about in the shareholders’ annual report. It just
does not make sense for the president to touting e.p.s. while his subordinates are rejecting
profitable projects like this one.’

The frustrated speaker was Sarah McNeil, product development manager of the
Consumer Products Division of Enager Industries, Inc. Enager was a relatively young
company, which had grown rapidly to its 2013 sales level of over $222 million (see
Exhibits 1 and 2 for its financial data for 2012 and 2013).

Enager had three divisions – Consumer Products, Industrial Products, and Professional
Services – each of which accounted for about one-third of Enager’s total sales. Consumer
Products, the oldest of the three divisions, designed, manufactured, and marketed a line
of houseware items, primarily for use in the kitchen. The Industrial Products Division
built one-of-a-kind machine tools to customer specifications (i.e., it was a large “job
shop”), with a typical job taking several months to complete. The professional Services
Division, the newest of the three, had been added to Enager by acquiring a large firm that
provided land planning, landscape architecture, structural architecture, and consulting
engineering servicies. This division has grown rapidly, in part because of its capability to
perform environmental impact studies, as required by law on many new land developing
projects.

Because of the differing nature of their activities, each division was essentially an
independent company. There were only a few corporate-level managers and staff people,
whose job was to coordinate the activities of the three divisions. One aspect of this
coordination was that all new project proposals requiring investment in excess of
$1,500,000 had to be reviewed by the chief financial officer, Henry Hubbard. It was
Hubbard who had recently rejected McNeil’s new Product Proposal, the essentials of
which are shown in Exhibit 3.

Performance Evaluation
The performance of each division was measured by return on investment (defines as net
income divided by total assets). In 2012, Enager has as its return on year-end assets a rate
of 5.2 percent. According to Hubbard, this corresponds to a “gross return” of 9.3 percent.;
he defined gross return as equal to earnings before interest and taxes (EBIT) divided by
assets. Hubbard felt that a company like Enager should have a gross (EBIT) return on
assets of at least 12 percent, especially given the interest rates the corporation had had to
pay on its recent borrowing. He, therefore, instructed each division manager that the
division was to try to earn a gross return of 12 percent in 2012 and 2013. In order to help

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pull the return up to this level, Hubbard decided that new investment proposal would
have to show a return of at least 15 percent in order to be approved.

2012-2013 Results
Hubbard and Randall were moderately pleased with 2013 results. The year was
particularly difficult one for some of Enager’s competitors, yet Enager had managed to
increase its returns on assets from 5.2 percent to 5.7 percent, and its gross return from 9.3
percent to 9.5 percent.
At the end of 2013, the president put pressure on the general manager of the Industrial
Product Division to improve its return on investment, suggesting that this division was
not “carrying its share of the load.” The division manager had bristled at this comment,
saying the division could get a higher return “if we had a lot of old machines the way
Consumer Products does.” The president had responded that he did not understand the
relevance of the division managers’ remark, adding, “I don't see why return on an old
assets should be higher than that on a new assets, just because the old one cost less.”
The 2014 results dissapointed and puzzled Randall. Return on assets fell from 5.7 percent
to 5.4 percent, and gross return dropped from 9.5 percent to 9..4 percent. At the same
time, return on sales (net income divided by sales) rose from 5.1 percent to 5.5 percent,
and return on owner’s equity also increased, from 9.1 percent to 9.2 percent. The
Professional Services Division easily exceeded the 12 percent gross returns target;
Consumer Products’ gross returns on assets was 10.8 percent, but Industrial Products’
return on assets was 6.9 percent. These results prompted Randal to say to Hubbard:

“You know, Henry, I’ve been a marketer most of my career, but until recently I thought I
understood the notion of return on investment. Now I see in 2013 our profit margin was
up and our earnings-per-share were up; yet two of your return on investment figures were
down, return on invested capital were down, and return on owners’ equity were up. I just
don't understand these discrepancies.
Moreover, there seems to be a lot more tensions among our managers the last two years.
The general manager of Professional Services seems to be doing a good job, and she’s
happy as a lark about the praise I’ve given to her. But, the general manager of Industrial
Products looks daggers at me every time we meet. And last week, when I was eating
lunch with the division manager at Consumer Products, the product development
manager came over to our table and really burned my ears over a new products proposal
of hers that we rejected the other day.”

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 EXHIBIT 1
INCOME STATEMENTS for 2012 and 2013 (in $000)
2012 2013
Sales $212,193 $222,675
Cost of Goods Sold 162,337 168,771
Gross Margin 49,886 53,904
Other Expenses
R&D 12,096 12,024
 Selling and General 19,521 20,538
 Interest 1,728 2,928
Total 33,345 35,490

Income Before Taxes 16,521 18,414

Income Tax Expense 5,617 6,261
Net Income 10,904 12,153

Earning-per-share (1,500,000 and 1,650,000 $7.27 $7.37

shares outstanding in 2012 and 2013)

EXHIBIT 3
BALANCE SHEET FOR 2012-2013 (in $000)
ACCOUNTS 2012 2013
ASSETS
Cash and Temporary Investments 4,212 4,407
Account Receivables 41,064 46,821
Inventories 66,486 76,401
Total Current Assets 111,762 127,629
Plant and Equipment
 Original cost 111,978 137,208
 Accumulated Depreciation 38,073 47,937
Net 73,905 89,271
Investment and other Assets 6,429 9,357
Total Assets 192,096 226,257
LIABILITIES AND OWNERS’ EQUITY
Account Payable 29,160 36,858
Taxes Payable 3,630 3,35
Current Portion of Long-term Debt 0 4,902
Total Current Liabiities 32,790 44,895
Deffered Income Taxes 1,677 2,955
Long-term Debt 37,866 46,344
Total Liabilities 72,333 94,194
Commont Stock 52,104 58,536
Retained Earnings 67,659 3,527
Total Owners’ Equity 119,763 132,063
Total Liabiities and Owners’ Equity 192,096 226,257

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 EXHIBIT 3
FINANCIAL DATA FORM NEW PRODUCT PROPOSAL
1. Projected Assets Investment
 Cash $150,000
 Account Receivable 450,000
 Inventories 900,000
 Plant and Equipment 1,500,000
Total $3,000,000
2. Cost Data
 Variable Cost per unit $9
 Differential Fixed Cost (per $510,000
year)
3. Price/Market Estimates (per year)
Unit Price Unit Sales Break Even Volume
$18 100,000 units 56,667 units
$21 75,000 units 42,500 units
$24 60,000 units 34,000 units