P13-26. 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 Operations July 27, July 28, Year Ended ($ millions) 2019 2018 Revenue Product $39,005 $36,709 Service 12,899 12,621 Total revenue 51,904 49,330 Cost of sales Product 14,863 14,427 Service 4.375 4,297 Total cost of sales. 19,238 18,724 Gross margin 32,666 30,606 Operating expenses Research and development 6,577 6,332 Sales and marketing 9.571 9,242 General and administrative. 1,827 2,144 Amortization of purchased intangible assets 150 221 Restructuring and other charges... 322 358 Total operating expenses 18,447 18,297 continued July 27, 2019 July 28, 2018 CISCO SYSTEMS Consolidated Statements of Operations Year Ended ($ millions) Operating income Interest income Interest expense Other income (loss), net. Interest and other income (loss), net. Income before provision for income taxes Provision for income taxes. Net income 14,219 1,308 (859) (97) 352 14,571 2,950 $11,621 12,309 1,508 (943) 165 730 13,039 12,929 $ 110 July 27, 2019 July 28, 2018 $11,750 21,663 $ 8,934 37,614 CISCO SYSTEMS INC. Consolidated Balance Sheets $ millions, except par value Assets Current assets Cash and cash equivalents. Investments... Accounts receivable, net of allowance for doubtful accounts of $136 at July 27, 2019 and $129 at July 28, 2018 Inventories Financing receivables, net Other current assets Total current assets. Property and equipment, net Financing receivables, net Goodwill.. Purchased intangible assets, net , Deferred tax assets Other assets... Total assets 5,491 1,383 5,095 2,373 47,755 2,789 4,958 33,529 2,201 4,065 2,496 $97,793 5,554 1,846 4,949 2,940 61,837 3,006 4,882 31,706 2,552 3,219 1,582 $108,784 Liabilities and equity Current liabilities Short-term debt. Accounts payable Income taxes payable. Accrued compensation Deferred revenue Other current liabilities Total current liabilities Long-term debt.. Income taxes payable. Deferred revenue. Other long-term liabilities Total liabilities .. $10,191 2,059 1,149 3,221 10,668 4,424 31,712 14,475 8.927 7.799 1,309 64,222 $ 5,238 1,904 1,004 2,986 11,490 4,413 27.035 20,331 8,585 8,195 1,434 65,580 continued July 27, 2019 July 28, 2018 continued from previous page CISCO SYSTEMS INC. Consolidated Balance Sheets $ millions, except par value 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 (Accumulated deficit) Retained earnings Accumulated other comprehensive income (loss) Total Cisco shareholders' equity.. Total equity. Total liabilities and equity 40.266 (5,903) (792) 33,571 33,571 $97,793 42,820 1,233 (849) 43,204 43,204 $108,784 Required a. Compute net operating assets (NOA) for 2019. 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. c. Use the parsimonious forecast method, as shown in Analysis Insight box on page 13-4, to forecast Cisco's sales, NOPAT, and NOA for 2020 through 2023 and the terminal period using the following assumptions. Sales growth 2020-2023 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 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). e. Cisco stock closed at $48.42 on September 5, 2019, the date the Form 10-K was filed with the SEC. How does your valuation estimate compare with this closing price? What do you believe are some reasons for the difference? What investment decision is suggested from your results? P13-26. Forecasting with the Parsimonious Method and Estimating Share Value Using the DCF Model Following are income statements and balance sheets for Cisco Systems. CISCO SYSTEMS Consolidated Statements of Operations July 27, July 28, Year Ended ($ millions) 2019 2018 Revenue Product $39,005 $36,709 Service 12,899 12,621 Total revenue 51,904 49,330 Cost of sales Product 14,863 14,427 Service 4.375 4,297 Total cost of sales. 19,238 18,724 Gross margin 32,666 30,606 Operating expenses Research and development 6,577 6,332 Sales and marketing 9.571 9,242 General and administrative. 1,827 2,144 Amortization of purchased intangible assets 150 221 Restructuring and other charges... 322 358 Total operating expenses 18,447 18,297 continued July 27, 2019 July 28, 2018 CISCO SYSTEMS Consolidated Statements of Operations Year Ended ($ millions) Operating income Interest income Interest expense Other income (loss), net. Interest and other income (loss), net. Income before provision for income taxes Provision for income taxes. Net income 14,219 1,308 (859) (97) 352 14,571 2,950 $11,621 12,309 1,508 (943) 165 730 13,039 12,929 $ 110 July 27, 2019 July 28, 2018 $11,750 21,663 $ 8,934 37,614 CISCO SYSTEMS INC. Consolidated Balance Sheets $ millions, except par value Assets Current assets Cash and cash equivalents. Investments... Accounts receivable, net of allowance for doubtful accounts of $136 at July 27, 2019 and $129 at July 28, 2018 Inventories Financing receivables, net Other current assets Total current assets. Property and equipment, net Financing receivables, net Goodwill.. Purchased intangible assets, net , Deferred tax assets Other assets... Total assets 5,491 1,383 5,095 2,373 47,755 2,789 4,958 33,529 2,201 4,065 2,496 $97,793 5,554 1,846 4,949 2,940 61,837 3,006 4,882 31,706 2,552 3,219 1,582 $108,784 Liabilities and equity Current liabilities Short-term debt. Accounts payable Income taxes payable. Accrued compensation Deferred revenue Other current liabilities Total current liabilities Long-term debt.. Income taxes payable. Deferred revenue. Other long-term liabilities Total liabilities .. $10,191 2,059 1,149 3,221 10,668 4,424 31,712 14,475 8.927 7.799 1,309 64,222 $ 5,238 1,904 1,004 2,986 11,490 4,413 27.035 20,331 8,585 8,195 1,434 65,580 continued July 27, 2019 July 28, 2018 continued from previous page CISCO SYSTEMS INC. Consolidated Balance Sheets $ millions, except par value 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 (Accumulated deficit) Retained earnings Accumulated other comprehensive income (loss) Total Cisco shareholders' equity.. Total equity. Total liabilities and equity 40.266 (5,903) (792) 33,571 33,571 $97,793 42,820 1,233 (849) 43,204 43,204 $108,784 Required a. Compute net operating assets (NOA) for 2019. 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. c. Use the parsimonious forecast method, as shown in Analysis Insight box on page 13-4, to forecast Cisco's sales, NOPAT, and NOA for 2020 through 2023 and the terminal period using the following assumptions. Sales growth 2020-2023 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 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). 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