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Estimating Cisco’s Future Cash Flows Case Solution & Answer

Estimating Cisco’s Future Cash Flows Case Solution

Executive Summary

The “Cisco Systems” is a networking industry pioneer. People, computer networks and computing devices are all connected through the company’s networking technologies, which enables the employees  to send and receive data regardless of location, time or computer machine. Investor Adam Stark intends to assess Cisco Systems’ approach as well as its long-term viability. Using its annual statement and other financial details; the firm was able to have ease in forecasting the cash flows for the upcoming years, in March 2016.

In 2016, renowned investor Adam Stark was considering to make an investment in Cisco System Inc., but he was worried about the company’s financial stability and performance. The investor decided to assess the investment by predicting potential cash flows using Cisco System Inc.’s past financial statements.He had planned to use time series analysis to assess the company’s potential results, but he was unsure regarding how to continue if the prior company’s data fails the predictability analysis of performance or future activities. The investor is particularly interested in learning how he can measure the probability that the company would produce comparable revenue in the current quarter as it did in the previous quarter. Furthermore, the investors should be concerned about the negative risks associated with investment valuation. The investor is especially curious about how he would be able to determine the likelihood that the firm can generate similar sales in the current quarter as it did in the previous quarter. Furthermore, the negative risks regarding investment valuation can be a source of concern for the investors.

To solve the investor’s problems; three alternative methods of analysis are used, which are: Ratio Analysis, Horizontal Analysis and Discounted Cash Flows. In Ratio analysis; several ratios are calculated for the year 2015 to 2016, which indicates that the overall performance of the company is improving as there is an increase in net profit margin and gross profit margin. Furthermore, there is also increase in dividend yield, which is beneficial for investor. Second method which was used,is Horizontal Analysis, in which historical data can be used to predict any reporting period. Changes of current reporting period is measured with the base year. This analysis also shows that company is performing well, and will perform better in future. Lastly Discounted Cash flow method is used to discount estimated future cash flows, which also shows positive results.

Among the all three methods; Ratio analysis is considered as the most suitable method according to this case, as it provides much clearer picture about the historical performance of the company, which can be a better predictor of future results.

Introduction

“Cisco System Incorporation” is a global technological enterprise that produces, designs, and provides high-tech goods and services to its end users. The business has achieved its agenda of getting a competitive edge over its rivals, showcasing the company’s long-term success, after implementing several courses of action.  The business is well-known for its expertise in high-tech industries. It is a worldwide pioneer in the area of networking. It is one of the most inspiring business success stories. The company’s initial product was delivered in 1986. This shipment provided an opportunity for the firm to gain exposure in the foreign market through gaining a significant market share in the industry. (Ghamat, 2016)

We should compare the company’s overall market position to its rivals in order to assess its performance. Furthermore, the company’s strategic development is focused on acquiring various firms in its industry in order to gain a greater market position in the foreign market. Others have benefited from the Cisco’s assistance in seizing new resources. The company’s key asset is its market identity, which has earned it a reputation as a technology pioneer. It has mostly concentrated on developing or designing technologies, with a constant  emphasis over high-growth markets.

Furthermore, the firm plans to increase its foreign market share by selling high-quality technology goods in order to draw more customers. The group is committed to not only delivering high-quality technology goods, but also to uphold its track record in product innovation. Although, the company is adaptable to any technical transition in the industry on an instant basis, which is the best feature that consumers like about the company and they tend to change as soon as technology improves.

The major competitors of the company are the big names, like: Amazon web services, Alcatel-Lucent, Arista Network, Avaya, Blue Jeans Network, ARRIS group, Brocade Communications, Citrix system, Dell, Check Point Software Technologies, Microsoft, IBM, Motorola and so on.

Problem Statement

In 2016, the renowned investor: Adam Stark, was considering to make an investment in Cisco System Inc., but he was worried about the company’s financial stability and its performance. The investor decided to assess the investment by predicting the potential cash flows using the Cisco System Inc.’s financial statements from past.

In order to analyze the company’s future performance, the method he used was “time series analysis”,but he was also uncertain about the method’s outcome, because the evidences from pastare highly unlikely to forecast any potential market success.

Furthermore, the investor needed to assess and ensure that the company performs similarly to the previous quarter’s results, since the cash flows in the previous quarter that ended in March 2016, were high.

Alternatives

There are several methods to analyze the future revenue, expenditure and cash flows of the company. Methods used in this case analysis are:

  • Ratio Analysis.
  • Horizontal Analysis.
  • Discounted Cash flows (DCF).

Ratio Analysis

Ratio analysis helps in comparing the company with its peers. It also helps in analyzing and comparing the historical data.Ratio analysis is a useful method for determining the viability of a business, assessing the operating performance, maintaining an adequate liquidity and representing overall financial power. The overall ratios of the company is indicating that the company is performing well and is expected to perform better in the future (Appendix 1).

The important ratios used by the investors are P/E ratio, which shows relationship between prices paid by investor to acquire share and how much earning is generated by the company on that share price. Another important ratio is EPS, which tells the earning per shareof the company;the greater the EPS, better is the company’s performance.

Some major ratios are

Gross Profit Margin

In 2016, the company’s gross profit margin increased to 63%, from 60 % in the previous year. This ratio means that the corporation is doing well and that there is more money left after expenses are deducted from the revenue.

Operating Profit Margin

 The company’s operating profit margin in 2016 is 26 percent, up from 22 percent in 2015, indicating that the company is earning sufficient operating profits to pay off its interest and taxes.

Net Profit margin

Net profit margin of company also increases to 22% in 2016 from 18% in 2015. This increase in margin is due to both factors, i.e. increase in net profit and revenue.

Return on Equity

The Return on Equity is increased by 2% from 2015 and reached 17% in 2016, as a result of which, the company has made more money from its equity investments in 2016 than it made in 2015.

Interest Cover

The interest cover of the company remained same for both years which is 19 times. This demonstrates that the company is not at greater risk of collapse, and the debt load is almost the same.

Dividend Payout Ratio

The dividend payout ratio decreased to 44% from 45% in 2015. This is the amount paid to shareholder from net income earned by the company. This is this ratio may result in dissatisfaction of the investors.

Dividend Yield

The dividend yield of the business increased to 3.8% in 2016 in comparison with 2015 where it was 2.8%, which results inan increase of dividends per share, i.e. from $0.80 to $0.94 in 2016. While a high dividend yield offers more dividends than the share’s price, which also means that the share’s price is undervalued, as the low P/E ratio indicates.

Current Ratio

The current ratio of company has increased from3.13 from 3.16 in 2015. The increase in current ratio means more liquid assets are available to payoff current liabilities of the company.

Uses of Ratio

Comparison: The ratio analysis helps the investors or analyst in comparing the company’s financial performance with other similar firms. It helps in identifying market gap, and competitive advantage of the company in comparison to its competitors that operate in the same sector. It also identifies the company’s strengths and weaknesses, which further helps The management in decision making.

Trend Line: Trend helps in forecasting the future performance of a company through historical data. The results can be predicted for large number of reporting periods, which helps in recognizing any expected financial turbulence that ratios alone would not be able to forecast for a single reporting period.

Operating Efficiency: Management also uses these ratios to know how efficiently its assets and liabilities are performing.

The benefits and drawbacks of using financial ratios to forecast the future business results are listed below:……………………..

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