Question 1) Why was McNeil's new product proposal rejected? Should it have been? Explain. McNeils' proposal was rejected because it did not meet the target return 15%, which was decided by Hubbard. However, the EVA is unfavorable under 15% return. Hubbard also states that a company like Enager should have a 12% return on EBIT. With this being said, McNeil's proposal demonstrates a return of 13% (ROA = EBIT/Assets = $390,000/$3,000,000), and a favorable EVA will be provided under this return figure. If cost of capital can be had for under 13%, then McNeil's proposal is a money maker for the Enager. In this case, McNeil’s proposal should not have been rejected. Additionally, an important goal of a business enterprise is to optimize shareholder returns, Anthony and Covindarajan (2007, P460) indicated that, however optimizing short-term profitability does not necessarily ensure optimum shareholder returns since shareholder value represents the net present value of expected future earnings. The consideration of this project did not take into account the time value of money. In this case, the decision may be misleading. To calculate the NPV of the project, there is more information needed (e.g. discount rate).
Question 2) What inferences do you draw from a cash flow statement for 1993? Is a break down by division useful? (Cf. Appendix 1)
In 1993, the operating activities have provided a positive cash flow of $24,711,000. The operating cash flow statement helps us to identify why this cash is not high enough to reach the management’s R.O.A. requirements. Indeed, depreciation ($9,864,000) represent 53,6% of the Net Profit after interest before tax ($18,414,000). The level of depreciation is high and the value of each division’s assets is certainly affected by the accumulation of depreciation. Therefore, the Industrial Products Division is right to wonder about the actual way of evaluating each division’s performance. The fourth part of this report provides a deeper analysis concerning this inference. Investing activities
The cash generated by the operating activities has totally been absorbed by the investing activities particularly through $25,230,000 purchases of plant and equipment. Again, these purchases have certainly increased the value of assets in the buying division. If the Industrial Products Division, as a new activity, is the one to require such investment, therefore, it is quite difficult for it’s manager to achieve a quick Return On Assets. Financing activities
The financing activities have generated a positive cash flow ($3,642,000) thanks particularly to a long-term debt cash inflow ($8,478,000) and the sale of share capital ($6,432,000). We can infer that the company has decided to raise more capital in order to cover its investments in plant and equipment. The investments have not damage the dividend payment ($12,546,000), which represent an important part (68,1%) of the Net Profit after interest before tax ($18,414,000).
A break down by division would be very useful and would allow to identify the cash flow generated by each department without taking into account depreciation in the operating performance. More over, it would lead to identify the life cycle (growth, maturity, and decline) of each division. Then, the performance measurement criteria should be unique to each division.
4- Evaluate the manner in which Randall and Hubbard have implemented their investment center concept. What pitfalls did they apparently not anticipate? Investment center concept:
Managers of investment center concept pay more attention on profits and investment. There are two approaches to measure their performance which is return on Asset (ROA) and residual income (RI). The calculation of ROA & RI:
ROA is the EBIT (operating profit) divided by average investment in the assets associated with the center. RI = EBIT (operation profit) - capital charge x investment center assets where the capital...
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