Forecasting with the Parsimonious Method and Estimating Share Value Using the DCF Model

Following are income statements and balance sheets for Cisco Systems.

Cisco Systems Consolidated Statements of Income
Years Ended December ($ millions)	July 27, 2019	July 28, 2018
Revenue
Product	$39,005	$36,709
Service	12,899	12,621
Total revenue	51,904	49,330
Cost of sales
Product	14,863	14,427
Service	4,375	4,297
Total cost of sales	19,238	18,724
Gross margin	32,666	30,606
Operating expenses
Research and development	6,577	6,332
Sales and marketing	9,571	9,242
General and administrative	1,827	2,144
Amortization of purchased intangible assets	150	221
Restructuring and other charges	322	358
Total operating expenses	18,447	18,297
Operating income	14,219	12,309
Interest income	1,308	1,508
Interest expense	(859)	(943)
Other income (loss), net	(97)	165
Interest and other income (loss), net	352	730
Income before provision for income taxes	14,571	13,039
Provision for income taxes	2,950	12,929
Net income	$11,621	$110

Cisco Systems Inc. Consolidated Balance Sheets
In millions, except par value	July 27, 2019	July 28, 2018
Assets
Current assets
Cash and cash equivalents	$11,750	$8,934
Investments	21,663	37,614
Accounts receivable, net of allowance for doubtful accounts	5,491	5,554
Inventories	1,383	1,846
Financing receivables, net	5,095	4,949
Other current assets	2,373	2,940
Total current assets	47,755	61,837
Property and equipment, net	2,789	3,006
Financing receivables, net	4,958	4,882
Goodwill	33,529	31,706
Purchased intangible assets, net	2,201	2,552
Deferred tax assets	4,065	3,219
Other assets	2,496	1,582
Total assets	$97,793	$108,784
Liabilities and equity
Current liabilities
Short-term debt	$10,191	$5,238
Accounts payable	2,059	1,904
Income taxes payable	1,149	1,004
Accrued compensation	3,221	2,986
Deferred revenue	10,668	11,490
Other current liabilities	4,424	4,413
Total current liabilities	31,712	27,035
Long-term debt	14,475	20,331
Income taxes payable	8,927	8,585
Deferred revenue	7,799	8,195
Other long-term liabilities	1,309	1,434
Total liabilities	64,222	65,580
Equity:
Cisco shareholders equity
Preferred stock, no par value: 5 shares authorized; none issued and outstanding	--	--
Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized;
4,250 and 4,614 shares issued and outstanding at July 27, 2019, and July 28, 2018, respectively	40,266	42,820
(Accumulated deficit) Retained earnings	(5,903)	1,233
Accumulated other comprehensive income (loss)	(792)	(849)
Total Cisco shareholders' equity	33,571	43,204
Total equity	33,571	43,204
Total liabilities and equity	$97,793	$108,784

(a) Compute net operating assets (NOA) for 2019. Hint: Treat Financing receivable as operating assets. NOA = $Answer

(b) Compute net operating profit after tax (NOPAT) for 2019, assuming a federal and state statutory tax rate of 22%. Assume that all items on the 2019 income statement will persist.(Round your answer to the nearest whole number.) 2019 NOPAT = $Answer

(c) Use the parsimonious forecast method, as shown in Analysis Insight box on page 13-4, to forecast Ciscos sales, NOPAT, and NOA for 2020 through 2023 and the terminal period using the following assumptions.

Sales growth 20202023	5%
Terminal growth	1%
Net operating profit margin	2019 rate rounded to three decimal places
Net operating asset turnover	2019 rate rounded to three decimal places

CSCO	Reported	Forecast Horizon				Terminal
($ millions)	2019	2020 Est.	2021 Est.	2022 Est.	2023 Est.	Period
Sales (rounded two decimal places)	Answer	Answer	Answer	Answer	Answer	Answer
Sales (rounded nearest whole number)	Answer	Answer	Answer	Answer	Answer	Answer
NOPAT (rounded nearest whole number)*	Answer	Answer	Answer	Answer	Answer	Answer
NOA (rounded nearest whole number)*	Answer	Answer	Answer	Answer	Answer	Answer

* Use sales rounded to nearest whole number for this calculation.

(d) Estimate the value of a share of Cisco common stock using the discounted cash flow (DCF) model as of July 27, 2019; assume a discount rate (WACC) of 7.6%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(8,747) million (NNO is negative, which means that Cisco has net nonoperating investments)

Instructions:

• Use your rounded answers for subsequent calculations.

• Round all answers to the nearest whole number, except for discount factors and stock price per share.

• Round discount factors to 5 decimal places.
• Round stock price per share to two decimal places.
• Use a negative sign with your NNO answer.

CSCO	Reported	Forecast Horizon				Terminal
($ millions)	2019	2020 Est.	2021 Est.	2022 Est.	2023 Est.	Period
DCF Model
Increase in NOA		Answer	Answer	Answer	Answer	Answer
FCFF (NOPAT - Increase in NOA)		Answer	Answer	Answer	Answer	Answer
Discount factor		Answer	Answer	Answer	Answer
Present value of horizon FCFF		Answer	Answer	Answer	Answer
Cumulative present value of horizon FCFF	Answer
Present value of terminal FCFF	Answer
Total firm value	Answer
NNO	Answer
Firm equity value	Answer
Shares outstanding (millions)	Answer
Stock price per share	Answer

(e) Cisco stock closed at $48.42 on September 5, 2019, the date the Form 10-K was filed with the SEC. How does your valuation estimate compare with this closing price? What do you believe are some reasons for the difference? What investment decision is suggested from your results? (Select all that apply)

Answer

Our stock price estimate is lower than the CSCO market price as of September 5, 2019, indicating that we believe the stock is overvalued.

Answer

Stock prices are a function of expected NOPAT and NOA, as well as the WACC discount rate.

Answer

Our lower stock price estimate may be due to more pessimistic forecasts or a higher discount rate compared to other investors' and analysts model assumptions.

Answer

Our higher stock price estimate may be due to more optimistic forecasts or a lower discount rate compared to other investors' and analysts model assumptions.