Cisco Systems, Inc. (CSCO), manufactures and sells networking and communications equipment for transporting data, voice, and video and provides services related to that equipment Its products include routing and switching devices; home and office networking equipment; and Internet protocol, telephony, security, network management, and software services. The firm has grown organically but also through acquisition of other networking and software firms. Cisco's Web site is at wwwcisco.com.

By any stretch of the imagination, Cisco Systems (CSCO) has been a strong growth company. A darling of the Internet boom of the late 1990s, it was one of the few technology companies tied to the Internet and telecommunications that prospered during that era.

Its products built the infrastructure of the Internet. While most Internet and telecommunications firms struggled and failed, their supplier, Cisco, capitalized on the new technology.

At one point in 2000, its market capitalization was over half a trillion dollars, the largest market capitalization of any firm, ever. Its P/E was over 130. The stock price increased from $10 in 1995 to $80 in 2000, supported by sales growth from $2.0 billion in 1995 to $18.9 billion in 2000.

However, with the subsequent collapse of the technology bubble and the demise of telecommunications firms such as WorldCom, Qwest, and AT&T, growth slowed considerably. Sales that peaked at $22.3 billion in fiscal year 2001 dropped to $18.9 billion by 2003 and recovered to the 2001 level only in 2004. The stock price also tumbled, reaching a low of a little over $8 in late 2002 after the firm reported a net loss for the year.

Cisco's 6,735 million shares traded at $21 each in September 2004, just after its results for fiscal year ending July 2004 had been published. You are asked to challenge this stock price, but only with information you glean from the financial statements. Exhibit 14.1 presents Cisco's comparative income statements and balance sheets for 2004 along with some additional information.

You should prepare simple valuations based on these statements. Use a required return of 10 percent for Cisco's operations. You might then introduce some scenarios for the future-s-speculation about sales growth and the level of profitability, for example-to see if the current price can be justified or whether reasonable speculation might justify an even higher price. You might also test how your valuations are sensitive to the required return you use. And you should apply reverse engineering tools to understand the forecasts that are implicit in the market price.

Additional Information

1. Long-term investment are comprised of the following (in millions of dollars):

All short-term investments are debt investments.
2. $50 million of cash and cash equivalents are regarded as operating cash.
3. Other income (loss) applies to gains and losses on investments.
4. The change in accumulated other comprehensive loss for both years was due almost entirely to unrealized gains and losses on investments.
5. The cash flow statements for 2004 and 2003 did not reveal any unusual accrual items affecting core income.
6. Cisco Systems' income tax rate (combined federal and state) is 36.8 percent.
7. The stock options footnote for 2004 reported the following (in millions of options):
The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value based on Cisco's closing stock price of $20.92 as of July 30, 2004, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of July 31, 2004, was 436 million. As of July 26, 2003, 748 million outstanding options were exercisable, and the weighted average exercise price was $26.12 As of July 27, 2002, 634 million outstanding options were exercisable, and the weighted-average exercise price was$23.51.

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2004 2003 2002 Equity investments Debt investments 1,134 9,464 10,598 745 1,422 12 167 567 8,233 8,800