HBSP Product Number TCG 003

THE CRIMSON PRESS CURRICULUM CENTER

THE CRIMSON GROUP, INC.

Enager Industries, Inc.

I don’t get it. I’ve got a new product proposal that can’t help but make money, and top management turns
thumbs down. No matter how we price this new item, we expect to make $390,000 on it pretax. That
would contribute over ten cents per share to our earnings after taxes, which is more than the 10-cent earn-
ings-per-share increase last year that the president made such a big thing about in the shareholders’ annual
report. it just doesn’t make sense for the president to be touting EPS while his subordinates are rejecting
profitable projects like this one.

The 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 current sales level of over $222 million. (See exhibits 1 and 2 for financial data.)
Enager had three divisions, Consumer Products, Industrial Products, and Professional Ser-
vices, each of which accounted for about one third of total sales. Consumer Products, the oldest
division, 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 the typical job taking several months to com-
plete. 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 services. This division had grown rapidly in part because of its capa-
bility to perform environmental impact studies, as required by law on many new land develop-
ment projects.
Because of the differing nature of their activities, each division was treated as an essentially
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 corporate vice president of finance, Henry Hubbard. It was Hubbard who had recently re-
jected McNeil’s new product proposal, the essentials of which are shown in Exhibit 3.

Performance Evaluation
Historically, each division had been treated as a profit center, with an annual division profit
budget negotiated between the president and the division’s general manager. At that time, Enag-
er’s president, Carl Randall, had become concerned about high interest rates and their impact on
the company’s profitability. At the urging of Mr. Hubbard, Mr. Randall had decided to begin
treating each division as an investment center so as to be able to relate each division’s profit to
the assets it used to generate its profits.
Starting two years ago, each division began to be measured based on its return on assets,
which was defined to be its net income divided by its total assets. Net income for a division was
calculated by taking its income before taxes and subtracting its share of corporate administrative
expenses (allocated on the basis of divisional revenues) and its share of income tax expense (the 

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This case was prepared by Professor James S. Reece. It is intended as a basis for class discussion and not to illus-
trate either effective or ineffective handling of an administrative situation.
Copyright © 2020 by James S. Reece and The Crimson Group, Inc. To order copies or request permission to repro-
duce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United
States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any
This document is authorized for use only in Prof. Shalini Kalra Sahi's Management Control / PGDM-IB at Management Development Institute - Gurgaon from Oct 2021 to Dec 2021.
form or by any means without written permission from The Crimson Group.
 tax rate applied to the division’s income after subtracting the allocated corporate administrative
expenses). Although Mr. Hubbard realized there were other ways to define a division’s income,
he and Mr. Randall preferred this method since it “. . . made the sum of the [divisional] parts
equal to the [corporate] whole.”
Similarly, Enager’s total assets were subdivided among the three divisions. Since each divi-
sion operated in physically separate facilities, it was easy to attribute most assets, including re-
ceivables, to the appropriate division. The corporate-office assets, including the centrally con-
trolled cash account, were allocated to the divisions on the basis of divisional revenue. All fixed
assets were recorded at their balance sheet values, that is, original cost less accumulated straight-
line depreciation.
Thus, the sum of the assets of the three divisions was equal to the amount shown on the cor-
porate balance sheet ($226,257) as of December 31 of the current year).
Two years ago, Enager had a return on assets (net income divided by total year-end assets) of
5.2 percent. According to Mr. Hubbard, this corresponded to a “gross return” of 9.3 percent; he
defined gross return as earnings before interest and taxes (EBIT) divided by total year-end assets.
Mr. 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 to pay on its recent bor-
rowings. He therefore instructed each division manager to try to earn a gross return of 12 per-
cent. In order to help pull the return up to this level, Mr. Hubbard decided that new investment
proposals would have to show a return of at least 15 percent in order to be approved.
Results of the Last Two Years
Messrs. Hubbard and Randall were moderately pleased with the results following the change
to investment centers, especially since that year was a particularly difficult one for some of
Enager’s competitors. Enager had managed to increase its return on assets from 5.2 to 5.7 per-
cent, and its gross return from 9.3 to 9.5 percent.
Despite these improvements, Mr. Randall had put pressure on the general manager of the In-
dustrial Products Division to improve its return on assets, suggesting that this division was not
“carrying its share of the load.” The division manager had taken exception to this comment, say-
ing the division could get a higher return “if we had a lot of old machines the way Consumer
Products does.” Mr. Randall had responded that he did not understand the relevance of this re-
mark, adding, “I don’t see why the return on an old asset should be higher than that on a new
asset, just because the old one cost less.”
The current year’s results both disappointed and puzzled Mr. Randall. Return on assets fell
from 5.7 to 5.4 percent, and gross return dropped from 9.5 to 9.4 percent, At the same time, re-
turn on sales (net income divided by sales) rose from 5.1 to 5.5 percent, and return on owners’
equity increased, from 9.1 to 9.2 percent. The Professional Services Division easily exceeded the
12 percent gross return target; Consumer Products gross return on assets was 10.8 percent, and
Industrial Products return was 6.9 percent (see Exhibit 4). These results prompted Mr. Randall to
say the following to Mr. 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 our profit margin was up and our earnings per share were up;
yet two of your return on investment figures were down, one - return on invested capital - held constant,
and return on owners’ equity went up. I just don’t understand these discrepancies.
Moreover, there seems to be a lot more tension among our managers the last two years. The general
manger of Professional Services seems to be doing a good job, and she seems pleased with the praise I’ve
given 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 devel-
opment manager came over to our table and expressed her frustration about your rejecting a new product
proposal of hers the other day

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Enager Industries • June 2020 � 2 of �5
 I’m wondering if I should follow up on the idea that Karen Kraus in personnel brought back from that
two-day organization development workshop she attended over at the university. She thinks we ought to
have a one-day offsite “retreat” of all the corporate and divisional managers to talk over this entire return
on investment matter.

Assignment
1. Why was McNeil’s new product proposal rejected? Should it have been?
2. Prepare a cash flow statement for the most recent year. Using it in conjunction with the comparative income
statements and balance sheets, what conclusions do you draw about Enager Industries’ financial health?
3 Evaluate the manner in which Messrs. Randall and Hubbard have implemented their investment center concept.
What pitfalls did they apparently not anticipate?
4. What, if anything, should Mr. Randall do now with regard to his investment center approach?

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Enager Industries • June 2020 � 3 of �5
 ENAGER INDUSTRIES, INC.
Exhibit 1. Income Statements
($000, except shares and earnings per share figures)
Year Ended December 31
Last Year This Year
Sales $212,193 $222,675
Cost of sales 162,327 168,771
Gross Margin $49,866 $53,904
Other Expenses:
Development $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
Shares outstanding 1,500,000 1,650,000
Earnings per share $7.27 $7.37

Exhibit 2. Balance Sheets ($000)

As of December 31
Assets Last Year This Year
Current assets:
Cash & temporary investments $4,212 $4,407
Accounts receivable 41,064 46,821
Inventories 66,486 76,401
Total current assets $111,762 $127,629
Plant & equipment:
Original cost 111,978 137,208
Accumulated depreciation 38,073 47,937
Net $73,905 $89,271
Investments & other assets 6,429 9,357
Total Assets $192,096 $226,257
Liabilities and Owners Equity
Current liabilities
Accounts payable $29,160 $36,858
Taxes payable 3,630 3,135
Current portion of long-term debt 0 4,902
Total current liabilities $32,790 $44,895
Deferred income taxes 1,677 2,955
Long-term debt 37,866 46,344
Total liabilities $72,333 $94,194
Common stock 52,104 58,536
Retained earnings 67,659 73,527
Total owners’ equity $119,763 $132,063

Total liabilities and owners’ equity $192,096 $226,257


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Enager Industries • June 2020 � 4 of �5
 ENAGER INDUSTRIES, INC.
Exhibit 3. Financial Data from New Product Proposal

1. Projected asset investment:*

Cash $ 150,000
Accounts receivable 450,000
Inventories 900,000
Plant and equipment † 1,500,000
Total $3,000,000

2. Cost data:
Variable cost per unit $9.00
Differential fixed costs (per year)‡ $510,000

3. Price/market estimates (per year):

Unit Price Unit Sales Break-even Volume

$18.00 100,000 56,667 units

21.00 75,000 42,500
24.00 60,000 34,000
* Assumes 100,000 units’ sales.
† Annual capacity of 120,000 units.
‡ Includes straight-line depreciation on new plant and equipment.

Exhibit 4. Calculation of Gross Return on Assets for Most Recent Year

(All dollar amounts in millions)

Fixed Total Gross

Division Sales EBIT W/C Assets Allocations Assets ROA
Consumer Products 74.3 10.8 60.8 34.6 4.6 100.0 10.8%
Industrial Products 74.2 7.2 44.4 54.7 4.6 103.7 6.9%
Professional Services 74.2 3.3 18.0 0.0 4.6 22.6 14.6%
Total 222.7 21.3 123.2 89.3 13.8 226.3 9.4%

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