Enager Essay

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CASE: Enager Industries, Inc. The case presents several issues resulting from the performance measures employed by Enager. These issues revolve around (1) use of an overestimated gross return criterion for approving new investment proposals, (2) comparison of three divisions as investment centers, and (3) erroneous interpretation of current financial results. The CFO’s target gross return for 1992 and 1993 was 12% which was based on the cost of capital of their investments. To achieve this, it was decided that all new investment proposals should have a return of at least 15%. Because of this criterion, the project proposal of development manager Sarah Mcneil, which has an estimated return of 13%, was rejected. This was not a sound decision for the company because the said project exceeded the target and would have improved the company’s then gross return of 5.2%. In this context, it is deemed that the company has set an overestimated return criterion of 15% when in fact, every project that offers a return greater than the cost of capital will be beneficial to the company. Rejected projects that are below the 15% criterion but exceed the cost of capital are forgone investment opportunities for the company. Enager is a well-diversified company, with all of its three divisions operating in practically different industries, thus requiring widely differing amounts and types of assets. Irrespective of this, top management looks at divisional performance (in terms of ROA) comparatively. The Professional Services Division, being in the services industry, is expected to have practically no fixed assets and very little working capital. Hence, despite having the lowest EBIT, it yielded the highest ROA (and even exceeded the gross return target) owing to a low denominator. The Consumers Products Division, the oldest of the three and is operating in the manufacturing

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