In 2016, Adam Stark, a renowned investor, was considering investing in Cisco System Inc. However, he was having second thoughts on the financial stability and performance of the firm. 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 performs similar to the previous quarter's performance as the cash flows in the prior quarter ending March 2016 was exceptionally high.
Hubert Pun and Salar Ghamat
Harvard Business Review (W16428-PDF-ENG)
July 06, 2016
Case questions answered:
- Introduction –Identify the key problem and summarize the thesis statement in 1 or 2 sentences.
- Background information – include relevant facts and issues. This will provide evidence that you have conducted additional research on the problem.
- Alternatives – describe several alternatives (at least three), describe existing constraints, and explain why some alternatives were rejected. These should be supported by both quantitative and qualitative analyses. The 3 alternatives we are to use for this case are: invest in Cisco Systems, do not invest in Cisco, and invest in Cisco but at a later date.
- Recommendation/Solution – provide one justifiable and realistic solution to the problem; explain the reasons behind the proposed solution. Support this solution with justification and include relevant theoretical concepts as well as the results of your research. Out of the 3 alternatives, which one is recommended? Also, what would be the price you purchase at if that is what is recommended?
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Case answers for Estimating Cisco's Future Cash Flows
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 and 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 among 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 51% share in witches and routers market. (Hamblen, 2019) NASDAQ Stock Exchange trades the organization’s shares with the ticker symbol “CSCO.” (Yahoo Finance, 2020)
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 performs similar to the previous quarter’s performance as the cash flows in the prior quarter ending March 2016, was exceptionally high.
To analyze the financial stability, performance, and predict its future profitability, ratio, and horizontal analyses for two years has been performed.
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.
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.
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.
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