In The World of trendsetting fashion, instinct and marketing savvy are prerequis
ID: 2798501 • Letter: I
Question
In The World of trendsetting fashion, instinct and marketing savvy are prerequisites to success. Jordan Ellis had both. In 2015, 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, while others featured it in canary yellow.
Encore had made it. The company's historical growth was spectacular. Who 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 predicted that the firm might encounter little or no growth in the future. They cautioned that stock holders also should expect no growth in future dividends.
Contrary to the conservative securities analysts, Jordan Ellis believed 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 the 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 assigned a junior financial analyst, Marc Scott, to evaluate the firm's current stock price. He has asked Marc to analyze the conservative predictions of the securities analysts and the aggressive predictions of the company founder, Jordan Ellis.
Marc has compiled the following 2015 financial data to aid his analysis.
Data item
2015 value
Earnings per share (EPS)
$6.25
Price per share of common stock
$40.00
Book value of common stock equity
$60,000,000
Total common shares outstanding
2,500,000
Common stock dividend per share
$4.00
1. Calculate answers for the following questions:
A. What is the firm's current book value per share?
B. What is the firm's current P/E ratio?
C. What is the current required return for Encore stock? What will be the new required return for Encore stock assuming that the firm expands into European and Latin American markets as planned?
D. If the securities analysts are correct and there is no growth in future dividends, what will be the value per share of the Encore stock ? (Note: Use the new required return on the company's stock here.)
E. lf Jordan Ellis's predictions are correct, what will be the value per share of Encore stock if the firm maintains a constant annual 6% growth rate in future dividends? (Note: Continue to use the new required return here.)
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 8% growth rate in dividends per share over the next 2 years and 6% thereafter?
Data item
2015 value
Earnings per share (EPS)
$6.25
Price per share of common stock
$40.00
Book value of common stock equity
$60,000,000
Total common shares outstanding
2,500,000
Common stock dividend per share
$4.00
Explanation / Answer
(1A)
Book Value per Share
= Current Book Value of Shares/Total No. of Outstanding Shares
= 60,000,000/2,500,000 = $24
(1B)
P/E Ratio = Price per Share/Earning per Share = 24/6.25 = 3.84
(1C) Using dividend discount model
The return from stock
re = D1/P0 + g
D1 - Divident at year 1
P0 - Current price of stock
g - Dividend growth
re = 4/24 + 0.06 = 22.7%
Beta of the stock based on present return
E(R) = Rf + Beta*Risk Premium
Beta = (22.7 - 6)/8.8 = 1.9
Since the risk premium will go up from 8.8% to 10% due to expand into European and Latin American markets.
Future E(R) = 6 + 1.9*10 = 25%
(1D)
If no growth in dividend then g= 0 for this equation
re = D1/P0 = 4/24 = 16.7%
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