Estimating Cisco’s Future Cash Flows – Case Solution

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Estimating Cisco's Future Cash Flows Case Answers

This case solution includes an Excel file with calculations.

Introduction – Estimating Cisco’s Future Cash Flows

The Cisco System Inc. is a USA-based Technology Company that was established in 1984 by Leonard Bosack and Sandra Lerner. The company has its headquarters in San Jose, California (Lewis, 2020). It is a multinational organization offering its products and services in more than 115 countries. (Cisco Australia, 2020) The organization develops, manufactures, and sells high-technology services and products, software, telecommunication equipment, and networking hardware.

The organization received various awards for providing the best workplace to Women millennials and supporting gender diversity. Also, Cisco System Inc. was ranked as the tenth best company on the list of top 100 companies by Forbes. In 2019, the corporation had scored 100% on the Corporate Equality Index. (Cisco, 2020)

In the same year, the company dominated the internet market by securing a 51% share in the witches and routers market. (Hamblen, 2019) NASDAQ Stock Exchange trades the organization’s shares with the ticker symbol “CSCO.” (Yahoo Finance, 2020)

Problem Statement:

In 2016, Adam Stark, a renowned investor, was considering investing in Cisco System Inc. but was concerned about the financial stability and performance of the firm. The investor wanted to evaluate the investment by using historical statements of Cisco System Inc. to predict future cash flows.

To evaluate the future performance of the company, he used time series analysis. Still, he was unsure regarding the results of the method as historical data does not predict the future performance of the business.

Moreover, the investor wanted to evaluate and ensure that the business performed similarly to the previous quarter’s performance, as the cash flows in the prior quarter ending March 2016 were exceptionally high.

Financial Analysis:

To analyze the financial stability performance and predict its future profitability, ratio and horizontal analyses for two years have been performed.

Ratio Analysis:

Gross Profit margin:

The Gross profit margin of Cisco System Inc. increased by 62% in the year 2016 as compared to 2015. This increase indicates that the company is financially healthy as more money is left after deducting the cost of goods sold from revenue.

Operating Profit Margin:

The organization achieved an operating profit margin of 28% as compared to 22% made in 2015, which indicates that the business is generating adequate operating income to pay off its interest and taxes.

Return on Equity:

The return on equity of the business had declined to 5% as compared to 15% in 2015. This value indicates that businesses earned less profits from their equity investments as compared to 2015. This decline might be an alarming factor for the investor as the company is not deploying the shareholder’s capital effectively.

P/E ratio:

The businesses’ price-to-earnings ratio declined to $9.6 in 2016 as compared to $10.02 in 2015. This ratio indicates that the investors do not demand the shares of the company, and they are reluctant to invest in the company’s shares. On the other hand, a declining P/E ratio indicates that the company’s shares are undervalued.

Debt to Equity ratio:

The debt-to-equity ratio indicates the business’s proportion of debt and equity used to finance the business’s assets. Cisco’s debt-to-equity ratio increased to 46% as compared to 42% in 2015, which indicates that the company relies more on debt to finance its assets and is experiencing difficulties in reducing the level of debt.

Interest cover:

The interest cover of the business decreased to 20 times in 2016 as compared to 33 times in 2015. These values show that the company is facing an increased risk of bankruptcy, and the business debt burden is too high concerning its real earning potential.

Dividend payout ratio:

The dividend payout ratio declined by 1% in the year 2016 as compared to the previous year, which indicates that less amount was paid to shareholders relative to the net income of Cisco Systems Inc. This decline might result in investor dissatisfaction and the sustainability of the business’s dividend payment stream.

Dividend yield:

The dividend yield of the business increased to 3.8% as compared to 2.8% in the previous year. This increase was the result of increasing dividends per share to $0.94 from $0.8 in 2015.

Although a high dividend yield provides more income as compared to the share’s price, it also indicates that the share’s price is undervalued, which is evident by the low P/E ratio.

Table 1- Ratio Analysis