Topic: Using ROPI in a Management Context

You have recently taken a position as CFO of Elwood Electronics Inc., a leading manufacturer of consumer electronics. The industry is widely regarded as one of the more stable across the economic spectrum and offers good long-term growth prospects. In addition to Elwood Electronics Inc., there are several other well-capitalized competitors, and each company commands roughly identical market shares. Each competitor has highly efficient manufacturing processes and operates at virtually identical margins. In your new position as CFO, your incentive compensation plan is primarily driven by ROPI. Elwood Electronics Inc. has historically been ROPI neutral while its peers in have been ROPI positive.

a. Looking at the information below, what would be your immediate objectives for Elwood Electronics Inc. in order to drive positive ROPI. Explain your actions.

Elwood Electronics Industry Peers

Net operating profit margin (NOPM) 10.5% 10.5%

Working Capital as % of NOA 18.0% 13.5%

Debt to market value of equity (%) 2.0% 28.0%

Cost of Debt 3.0% 3.0%

Cost of Equity 8.0% 9.0%

Weighted average cost of capital (WACC) 9.5% 8.0%

Topic: ROPI Model

b. Explain the concept behind the Residual Operating Income (ROPI) model.

Topic: Advantages/Disadvantages of DCF and ROPI Models

c. Name and describe some of the advantages/disadvantages of both the Discounted Cash Flow (DCF) and the Residual Operating Income (ROPI) valuation models.