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

Following are the income statement and balance sheet for Cisco Systems for the year ended July 30, 2016.

(a) compute the return on assets (ROA) and return on equity (ROE) for 2016

(b) Complete the DuPont disaggregation of return on equity (ROE) for 2016. Analyze the DuPont financial ratios and discuss how Cisco Systems Inc. can achieve a high ROE.

(c) Compute net operating assets (NOA) for 2016.

(d) Compute net operating profit after tax (NOPAT) for 2016, assuming a federal and state statutory tax rate of 37%. (Round your answer to the nearest whole number.)

(e) Forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions:

Sales growth 2017	2%
Sales growth 2018-2020	3%
Terminal growth	1%
Net operating profit margin	2016 rate rounded to 3 decimal places
Net operating asset turnover	2016 rate rounded to 3 decimal places

Assume a discount rate (WACC) of 12%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(37,113) million (NNO is negative which means that Cisco has net nonoperating investments).

(f) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and sales, NOPAT and NOA forecast in (e);

(g) If Ciscos top management were optimistic about CISCOs market growth opportunities and revised their sales growth rates up by 5%, please forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions:

Sales growth 2017	7%
Sales growth 2018-2020	8%
Terminal growth	1%
Net operating profit margin	2016 rate rounded to 3 decimal places
Net operating asset turnover	2016 rate rounded to 3 decimal places

(h) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and the sales forecast in (g); Note, we still assume a discount rate (WACC) of 12%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(37,113) million.

(i) Cisco stock closed at $31.47 on September 8, 2016, the date the Form 10-K was filed with the SEC. How does your DCF valuation estimates compare with this closing price? What do you believe are some reasons for the difference? What investment decision is suggested from your results?

(j) Are there other equity valuation models? Please discuss the advantages and disadvantages of different equity valuation models.

Cisco Systems Inc. Consolidated Balance Sheets In millions, except par value 30-Jul-16 25-Jul-15 Assets Current assets Cisco Systems Inc Consolidated Statements of Income Cash and cash equivalents 7,631 6,877 Investments Years Ended (Dec (SM) 58,125 53,539 30-Jul-16 25-Jul-15 Accounts receivable, net of allowance for 5,847 5,344 Revenue doubtful accounts of $249 at July 30, 2016 Product 37,254 37,750 and $302 at July 25, 2015 Service 11,993 11,411 Inventories 1,217 1,627 Total Revenue 49,247 49,161 Financing receivables, et 4,272 4,491 Cost of Sales Other current assets 1,627 1,490 Product 14,161 15,377 Total current assets 78,719 73,368 Service 4,126 4,103 Total cost of sales 18,287 19,480 Property and equipment, net 3,506 3,332 Gross margin 30,960 29,681 Financing receivables, net 4,158 3,858 Goodwill 26,625 24,469 Operating expenses Purchased intangible assets, net 2,501 2,376 Deferred tax assets 4,299 4,454 R&D 6,296 6,207 Other assets 1,844 1,516 Sales and Mktg 9,619 9,821 Total assets 121,652 113,373 General and admin 1,814 2,040 Amortization of purchased intangible assets 303 359 Liabilities Restructuring and other charges 268 484 Current liabilities Total Operating expenses 18,300 18,911 Short term debt 4,160 3,897 Operating income 12,660 10,770 Accounts payable 1,056 1,104 Income taxes payable 517 62 Interest income 1,005 769 Accrued compensation 2,951 3,049 Interest expense (676) Deferred revenue 10,155 9,824 (566) Other current liabilities Other income (loss), net 6,072 5,476 (69) 228 Total current liabilities 24,911 23,412 Interest and other income (loss), net 260 431 Long term debt 24,483 21,457 Income before provision for income taxes 12,920 11,201 Income taxes payable 925 1,876 Provision for income taxes 2,181 2,220 Deferred revenue 6,317 5,359 Other long-term liabilities 1,431 1,562 Net income. 10,739 8,981 Total liabilities 58,067 53,666 Cisco Systems Inc Consolidated Balance Sheets In millions, except par value Cisco shareholders' equity Preferred stock, no par value: 5 shares authorized; none issued and outstanding Common stock and additional paid in capital, .001 par value: 20000 shares authorized; 5029 and 5085 shares issued and outstanding at July 30, 2016 and July 25, 2015 respectively 30-Jul-16 25-Jul-15 44,516 43,592 Retained earning Accumulated other comprehensive 19,396 (326) 16,045 61 income (loss) Total Cisco shareholders' equity 63,586 9,698 Noncontrolling interests (1) 9 Total Equity 63,585 9,707 Total liabilities and equity 121,652 113,373