March 14, 2002Cisco Systems was founded in 1984 by a group of computer scientist from Stanford University. Cisco is now the worldwide leader in networking for the internet (www.cisco.com). Cisco Protocol-based (IP) networking solutions are the foundation of the internet and most corporate, education, and government networks around the world. Cisco provides the broadest line of solutions for transporting data, voice and video within for companies all over. Cisco employees 36,786 employees worldwide with 14,522 employees from the Bay Area (www.cisco.com). Their headquarters is located in San Jose, California. Cisco has had great success until last year where they had a negative return. This is due largely to the crashing of the dot com industry in the Silicon Valley. We choose to do our project on Cisco because we believe that they will bounce back and continue to be successful for many years to come.
Our first step was to project, for the next 5 years, the Balance Sheet, Income Statement, and Cash Flow statement based solely on last years financial statements and NOT a trend line, or least of squares method of all previous years. We arbitrarily chose percentage increases from year to year starting in 2002 with a 10% increase, followed by 5% in 2003, 15% in 2004, 2% in 2005, and then a constant growth of 5%. With those projections we were able to estimate the Free Cash Flow Model (using 10% WACC) and came up with the present value of Cisco based on our projected financials (see attachments). We took the present value of the firm and divided it by the outstanding shares to derive the value of the firm based on these projections. The value was negative ($â€“2.069) which contrasted greatly with the actual stock price of $15.00 on March 1, 2002. We then went back and adjusted our projected financials until our valuation of the firm equaled the value of Cisco on March 1, 2002.
Below are the changes we made in our projections to bring our free cash flow and net present value of the company back to the actual market value of Cisco on March 1, 2002 of $15.00. We left our percentage increases the same each year, but took an executive administrators position in the company and made the following changes:
â€¢ 2002 Decreased R&D from 4,314 to 3,000
â€¢ 2002 Increased Sales & Marketing from 5,826 to 6,000
â€¢ 2002 Decreased General Admin. from 856 to 625
â€¢ 2002 Decreased In-Process R&D from 941 to 855
â€¢ 2003 Increase of Net Sales from 25,748 to 36,250
We believe these changes in Net Sales are possible due to our increase in Sales and Marketing, and our future outlook on the market, and specifically Cisco Systems. This change in Net Sales in addition to our â€œthinning outâ€ of administration and R&D costs directly effect our growth model (see attached) where our valuation of the stock price went from â€“2.069 to 15.000
From this project we learned many financial concepts, but to name a few we specifically learned how to valuate a firms stock based on projections and using a constant growth model. We learned how to work backwards with this same model to see what the possible reasons are for a stock price to be what it is. We also found out that if a firm has a loss for a year that it is important for them to bounce back and achieve a large return, otherwise the firm will have not have a positive net present value and will therefore need to either be liquidated, or go through reorganization (if a companyâ€™s NPV is negative, they would â€œtechnicallyâ€ have to pay people to buy their stock, which would never happen). This is what happened to the company Neopost (where Joey works) 10 years ago, they were not even able to sell the company for $1 because it had a negative net present value.
Cisco Systems â€œInvestor Realationsâ€, http://investor.cisco.com/ireye/ir_site.zhtml?ticker=csco&script=11945&layout=7&item_id=’his_financials110501.html’ (2 February 2002)
Eugene F. Brigham, Louis C. Gapenski, and Phillip R. Daves, Intermediate Financial Management Sixthe Edition (The Dryden Press, 1999)