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Estimating Share Value Using the ROPI Model

Following are forecasts of Illinois Tool Works Inc. sales, net operating profit after tax (NOPAT), and net operating assets (NOA) as of December 31, 2018.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

	Reported	Forecast Horizon Period				Terminal
$ millions	2018	2019	2020	2021	2022	Period
Sales	$14,768	$15,654	$16,593	$17,589	$18,644	$19,017
NOPAT	2,711	2,880	3,053	3,236	3,430	3,499
NOA	9,462	10,028	10,630	11,268	11,944	12,183

Answer the following requirements with the following assumptions:

Assumptions
Terminal period growth rate	2%
Discount rate (WACC)	7.35%
Common shares outstanding	328.1	million
Net nonoperating obligations (NNO)	$6,204	million

(a) Estimate the value of a share of ITW’s common stock using the residual operating income model (ROPI) model as of December 31, 2018.

(b) Illinois Tool Works Inc. closed at $144.21 on February 15, 2019, the date the 10-K was filed with the SEC. How does your valuation estimate compare with this closing price?

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Question 2

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Estimating Share Value Using the ROPI Model

Following are forecasts of sales, net operating profit after tax (NOPAT), and net operating assets (NOA) as of December 31, 2018, for Humana.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

	Reported	Horizon period				Terminal
$ millions	2018	2019	2020	2021	2022	Period
Sales	$56,912	$57,766	$58,632	$59,512	$60,404	$61,008
NOPAT	2,492	2,542	2,580	2,619	2,658	2,684
NOA	4,032	4,097	4,158	4,221	4,284	4,327

Answer the following requirements with the following assumptions:

Assumptions
Terminal period growth rate	1%
Discount rate (WACC)	7.8%
Common shares outstanding	135.6	million
Net nonoperating obligations (NNO)	$(6,129)	million

NNO is negative because Humana’s nonoperating assets exceed its nonoperating liabilities.

(a) Estimate the value of a share of common stock using the residual operating income (ROPI) model as of December 31, 2018.

(b) Humana (HUM) stock closed at $307.56 on February 21, 2019, the date the 10-K was filed with the SEC. How does your valuation estimate compare with this closing price?

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Forecasting with the Parsimonious Method and Estimating Share Value Using the ROPI Model

Following are income statements and balance sheets for Cisco Systems.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

Cisco Systems
Consolidated Statements of Income
Years Ended December ($ millions)	July 27, 2019	July 28, 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
Operating income	14,219	12,309
Interest income	1,308	1,508
Interest expense	(859)	(943)
Other income (loss), net	(97)	165
Interest and other income (loss), net	352	730
Income before provision for income taxes	14,571	13,039
Provision for income taxes	2,950	12,929
Net income	$11,621	$110

Cisco Systems Inc.
Consolidated Balance Sheets
In millions, except par value	July 27, 2019	July 28, 2018
Assets
Current assets
Cash and cash equivalents	$11,750	$8,934
Investments	21,663	37,614
Accounts receivable, net of allowance for doubtful accounts	5,491	5,554
Inventories	1,383	1,846
Financing receivables, net	5,095	4,949
Other current assets	2,373	2,940
Total current assets	47,755	61,837
Property and equipment, net	2,789	3,006
Financing receivables, net	4,958	4,882
Goodwill	33,529	31,706
Purchased intangible assets, net	2,201	2,552
Deferred tax assets	4,065	3,219
Other assets	2,496	1,582
Total assets	$97,793	$108,784
Liabilities and equity
Current liabilities
Short-term debt	$10,191	$5,238
Accounts payable	2,059	1,904
Income taxes payable	1,149	1,004
Accrued compensation	3,221	2,986
Deferred revenue	10,668	11,490
Other current liabilities	4,424	4,413
Total current liabilities	31,712	27,035
Long-term debt	14,475	20,331
Income taxes payable	8,927	8,585
Deferred revenue	7,799	8,195
Other long-term liabilities	1,309	1,434
Total liabilities	64,222	65,580
Equity:
Cisco shareholders’ equity
Preferred stock, no par value: 5 shares authorized; none issued and outstanding	0	0
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	40,266	42,820
(Accumulated deficit) Retained earnings	(5,903)	1,233
Accumulated other comprehensive income (loss)	(792)	(849)
Total Cisco shareholders’ equity	33,571	43,204
Total equity	33,571	43,204
Total liabilities and equity	$97,793	$108,784
Federal and state statutory tax rate	22%

(a) Compute net operating assets (NOA) for 2019.

Hint: Treat Financing receivable as operating assets.

(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 14-5 and in Exhibit 14.2, to forecast Cisco’s sales, NOPAT, and NOA for 2020 through 2023 and the terminal period using the following assumptions.

Note: When completing the question in Excel, refer directly to the cells containing calculated assumptions for NOPM and NOAT, i.e., don’t type the NOPM number when making a calculation, refer to the cell.

Assumptions
Sales growth 2020–2023	5%
Terminal growth	1%
Net operating profit margin (NOPM)		2019 rate
Net operating asset turnover (NOAT)		2019 rate

Hint: Use 2019 NOA, not average NOA, to compute the 2019 rate for NOAT.

(d) Estimate the value of a share of Cisco common stock using the residual operating income (ROPI) 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).