Case Study, Encore International In the world of trendsetting fashion, instinct

Question

Case Study, Encore International

In the world of trendsetting fashion, instinct and marketing savvy are prerequisites to success. Jordan Ellis had both. During 2012, his international casual-wear company, Encore, rocketed to $300 million 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 color. Some shops showed the entire line in mauve, and others featured it in canary yellow.
Encore had made it. The company's historical growth was so spectacular that no one could have predicted it. However, securities analysts speculated that Encore could not keep up the pace. They warned that competition is fierce in the fashion industry and that the firm might encounter little 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 expansion plan into European and Latin American markets. Venturing into these markets was expected to cause the risk of the firm, as measured by the risk premium on its stock, to increase immediately from 8.8% to 10%. Currently, the risk-free rate is 6%.
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 of the securities analysts and the aggressive predictions of the company founder, Jordan Ellis.
Marc has compiled these 2012 financial data to aid his analysis:

Explanation / Answer

I disagree with the answers given above for the following reasons:

d) If the securities analysts are correct and there is ** NO GROWTH ** in future dividends (zero growth model) what will be the value per share of the Encore Stock?

PV = CF / r -----> (Zero Growth formula)

PV = $4 / 16%

PV = $4 / .16 = $25

e 1) If Jordan Ellis's predictions are correct, what will be the value per share of the Encore stock if the firm maintains a **CONSTANT** annual 6% growth ratein future dividends (Constant growth model)? (note in the text to use the new required return rate)

Formula (simplified): P0 = D1 / (r - g) ----->(Constant growth formula)

P0 = $4 / (16% - 6%) -- (new required rate of return - growth)

P0 = $4 / (.16 - .06)

P0 = $4 / .10 = $40

Same for the 8% (e-2)

P0 = $4 / (16% - 8%)

P0 = $4 / (.16 - .08)

P0 = $4 / (.08) = $50

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