Estimating Cisco’s Future Cash Flows Case Study Solution
Alternatives
The set of alternatives are recommended to Stark to make strategic decision on the basis of the current and past performance of the company. It would allow him to predict the performance of the company in near future more realistically. He could make a use of the historical company’s data as it provides the valuable insights on predicting the company’s future performance.
Alternative-1: Financial Ratio Analysis
The ratio analysis is helpful tool in measuring the company’s profitability, evaluates operational efficiency, ensure suitable liquidity, and reflect the overall financial strength. The ratios can be compared with the prior year ratios in order to evaluate the progress of the company over the period of time (Pooja Gupta, 2017).
The pros and cons of making the use of financial ratios to predict the future company’s performance are discussed below;
Pros
- It helps in validating or disproving the investment, financing and operating decisions of the company. The ratios helps in evaluating and comparing the financial position of the company as well as the results of the management or investor’s decisions.
- It allows the investors to conduct comparison with the industry trends, other firms and intra-firm comparison. This in turn provide valuable insights to understand the financial standing of the company in the economy.
- It helps in understanding firm’ business risk through calculating the leverages including operating leverages and financial leverages. It provides assistance in evaluating that how profitable the company is with respect to its debt outstanding and fixed cost deployment.
- It provides valuable insight onto the profitability, performance and overall earning power of the business.
- The trend can be conducted for the future plans and forecasting and helps investor in their decision making.
- It also simplifies the complex accounting standard and financial data into financial efficiency, operating efficiency, solvency and long term position.
Cons
- All the data used in conducting ratio analysis is derived from the actual results of historical data, which does not supposed to carry forward into the future.
- The information on the income statement of the company is stated in the current cost, whereas the information on the balance sheet of the company is stated in the historical cost, which in turn might result into the unusual results of the ratios.
- It illustrates the association between prior information and data while the investors seek and are more concerned about future and current data.
Alternative-2: Discounted Cash Flow Analysis
The discounted cash flow analysis is another method used by investors to estimate the future return on the invested capital for the time value of money (Schill, 2015).
The pros and cons of using such method to predict the future profitability of the company are discussed below;
Pros
- It is widely used to measure the investment’ attractiveness, it rely on the cash flow of the company.
- The analysis also includes the future expectations, also the internal rate of return is used to estimate the potential investment’ profitability.
- It can be used to assess the value and profitability of the company in future.
- The terminal value helps in determining the position of the company.
- It includes intrinsic value of the business and major assumptions related to the business.
- It also tells how much the stock of the company is under-valued or over-valued and whether the company’s price of stock is justified or not.
- It allows the investors to embed the key changes in the company’s business strategy in the model of valuation, which otherwise would be unreflect in other model used for valuation such as APV etc.
Cons
- The DCF calculation requires large number of assumptions and is sensitive to the certain or little changes in assumptions.
- It is the ever-changing target that tend to demand constant modification and vigilance. In case of any change in the company, the fair value would be change accordingly.
Alternative-3: Horizontal Analysis
The pros and cons of using such method to predict the future profitability of the company are discussed below;
Pros
- It allow the investors to assess the significant and relative changes in the items as well as project those item into the future.
- It helps in analyzing the situation of the trend.
- It helps in evaluating the long term solvency position and short term liquidity position of the company.
Cons
- It becomes useless at the time of the inflation or price level changes, hence provides the misleading results.
- It does not follow the accounting convention and concepts vigilantly.
Recommendation
After taking into consideration the key methods to predict the company’s profitability, various alternatives are discussed to ease Stark in determining the cash flows and trend of profit of the company by using most effective and suitable tool.
Stark is advised to heavily rely on the ratio analysis to predict the future profitability of the company due to the fact that it would give a better picture of financing standing ad position prior to years. It would assist in tend analysis which involves comparison of the company over time. Stark could make the quick decisions on the basis of the decisive matrices usually followed by the potential investors when they contemplate to invest in the certain organization (Cohen, 2000). Hence, the ratio analysis would help him in decision making through providing financial position of the company. Also, he would be able to evaluate the efficiency of the company in terms of operations and management.
Conclusion
Adam Stark has been contemplating to evaluate the strategy of the Cisco System Inc. by using the financials which includes income statement of the company. In doing so, he would be able to better predict where the company would stand and what amount of cash flows it would be generated in the forthcoming years. The ratio analysis is recommended over horizontal, trend and discounted cash flow analysis because it helps in validating or disproving the investment, financing and operating decisions of the company. The ratios helps in evaluating and comparing the financial position of the company as well as the results of the management or investor’s decisions.....................................
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