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CASE OF ENCORE INTERNATIONAL In the world of trend-setting fashion, instinct and marketing sawy are prerequisites to success. Jordan Ellis had both. During 2011, his international casual- wear company, Encore rocketed to 3300 mlllion In sales after 10 years in business. His fashion line covered the young woman from head to toe with hats, sweaters, dresses, blouses, skirts, pants, sweatshirts, socks, and shoes.

In Manhattan, there was an Encore shop every five or six blocks, each featuring a different colour. Some showed the entire line in mauve, and others featured it in canary yellow. Encore had made it. pectacular that had ora securities analysts sp ule • to view the pace. They warn industry and that the growth was so cted it. However, Id not keep up rce in the fashion tle or no growth in the future. They estimated that stockholders also should expect no growth in future dividends.

Contrary to the conservative securities analysts, Jordan Ellis felt that the company could maintain a constant annual growth rate in dividends per share of 6% in the future, or possibly 8% for the next 2 years and 6% thereafter. Ellis based his estimates on an established long-term expanslon plan Into European and Latin American markets. Venturing into these markets was expected to cause risk of the firm, as measured by beta, to increase immediately from 1. 10 to 1. 25.

In preparing the long-term financial plan, Encore’s chief financial officer has assigned a junior financial analyst, Marc Scott, to evaluate the firm’s current stock Price. He has asked Marc to consider the conservative predictions ofthe securities analysts and the aggressive predictions of the company founder, Jordan data to aid his analysis: Data item Earnings per share Price per share of common stock Book value of common stock equity Total common shares outstanding Common stock dividend per share Data points 2011 value $6. 25 $40. oo $4. 00 g (beta) 0. 0 0. 5 0. 50 0. 75 1. 0 1 . 25 I . 50 1. 75 2. 00 r (required return)% 6. 00 8. 00 10. 00 12. 00 14. 00 16. 00 18. 00 20. 00 22. 00 Answer to the following questions! a. ) Plot the graph of the Security Market Line using data above! 6 b. ) What IS the firm’s current book value per share? Book value per share= $ 60 ,000 ,000 2, 500 ,ooo c. ) Usine the CAPM calcul 24 red returns for Encore Risk Premium -110% I e. ) Ifthe securities analysts are correct and there is no growth n the future dividends, What Will be the value per share of the Encore stock? (Beta is f. If Jordan Ellis’s predictions are correct, What Will be the value per share of Encore stock if the firm maintains a constant annual growth rate of 6% in the future dividends? (Beta is g. ) If Jordan Ellis’s predictions are correct, what Will be the value growth rate of 8% per share in the future dividends over the next 2 years and 6% thereafter? (Beta is 1. 25)* Constant Growth: I Variable Growth Model: Present Value of Dividends Po — Present value of dividends during initial growth period + resent value of Price of stock at end of growth period.

PAGF3ÜFd PV of Stock at the end of year 2 (2005) P2005 I = I [D2006 – g2)] I pv P2 2yrs. ) I = | $4. 94 c (. 16-. 06) 49,401 1 = | $49. 40 x(. 743) 36,70 Step 4: Sum of present value of dividends during initial growth period and present value Price of stock at end of growth period I P2003 1 $7. 18+$36. 70 43,88 | I h. ) Compare the current stock Price of the stock and the stock values found in asterisked* questions (b,e,f,g). Discuss why these values may differ. Which valuation method do you think most clearly represents the true value of the Encore stock?

Valuation Method Market Value I BookValuel I $ Zero Growth I Constant Growth Variable Growth I Per 40,00 I I 24,00 | 25,00 42,40 | The book value has no relevance to the true value of the firm. Of the remaining methods, the most conservative estimate of value is given by the zero growth model. Wary analysts may advise paying no more than 325 per share, yet this is hardly more than book value. The most optimistic prediction, the variable growth model, results in a value of $43. 88, which is not far from the market value. The market is obviously not as cautious about Encore Internationalis future as the analysts.