TOMAS CLAUDIO COLLEGES

College of Business and Accountancy

Taghangin, Morong, Rizal

Encore International

In the world of trendsetting fashion, instinct and marketing savvy are

prerequisites to success. Jordan Ellis had both. During 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, 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 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 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.
 TOMAS CLAUDIO COLLEGES
College of Business and Accountancy
Taghangin, Morong, Rizal

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

 TOMAS CLAUDIO COLLEGES
College of Business and Accountancy
Taghangin, Morong, Rizal

Summary
Encore International, a casual-wear company, has spectacular growth after 10
year of business and plan to have long-term expansion into European and Latin
American markets while maintaining its growth in future dividends.

i. Objective

Encore International is a company that has spectacular growth. However, the

analysts speculated that Encore might encounter little or no growth in the future and no
growth in future dividends. On the contrary, Jordan Ellis, the company founder, felt that
the company could maintain constant annual growth rate in dividends per share of 6%,
8% for the next 2 years and 6% thereafter based on the expansion plan to European
and Latin American markets. This expected to cause the risk from 8.8% to 10%. The
risk-free rate is 6%. Encore’s CFO assigned junior financial analyst, Marc Scott, to
evaluate the firm’s current stock by considering the conservative’s and Jordan Ellis’s
predictions.

II. 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

 TOMAS CLAUDIO COLLEGES
College of Business and Accountancy
Taghangin, Morong, Rizal

TO DO

a. What is the firm’s current book value per share?

Firm’s current book value per share:

Book Value = $ 60,000,000 = $ 24

Shares outstanding 2,500,000

b. What is the firm’s current P/E ratio?

Firm’s current P/E ratio:

Price per share of common stock = $ 40.00 = 6.4

Earnings per share (EPS) $ 6.25

c. What is the required return of Encore stock?

Risk premium

1. Current: = RFR + βstock (Rmarket – RFR)

= 6% + β (8.8%) assume βstock = 1
= 6% + 1 (8.8%)
= 14.8%

2. After expand: = RFR + βstock (Rmarket – RFR)

 = 6% + 1 (10%) assume βstock = 1
= 16%

TOMAS CLAUDIO COLLEGES

College of Business and Accountancy
Taghangin, Morong, Rizal

d. What will be the value per share of Encore stock assuming there is no growth in
future dividends?

P𝑜 = D = $ 4 x 1 1 because there is no growth in dividend

K-g 16% - 0

= $ 4
16%

= $ 25

e. What will be the value per share of Encore stock if Jordan Ellis’s predictions are
correct?

1. Value per share with 6% future dividends growth

P𝑜 = D = $ 4 x 1.06
K-g 16% - 6%

= $ 4.24
10%

= $ 42.4

2. Value per share with dividend growth of 8% in next 2 years and 6%

thereafter

P𝑜 = $ 4 x (1.08) + $ 4 x (1.08)𝑥 2 + $ 4 x (1.08)𝑥 2 x (1 + 6%)

 (1.16) (1.16)𝑥 2 16%-6%
(1.16)𝑥 2

TOMAS CLAUDIO COLLEGES

College of Business and Accountancy
Taghangin, Morong, Rizal

= $ 3.72 + $ 3.47 + 4.67 x (1.06)

10%
(1.16)𝑥 2

= $ 7.19 + $ 49.5
(1.16)𝑥 2

= $ 7.19 + $ 36.79

= $ 43.98

f. Which valuation method do you believe most clearly represents the true value of
the Encore stock?

Valuation method Value

Book value per share $ 24
Zero growth $ 25
Constant growth $ 42.4
Variable growth $ 43.98
Stock price $ 40

The values are different because of the differences in dividend growth.

Book value per share: it cannot be used as stock valuation since it has no
relevance to the true value of the firm.

Zero growth: it is the most conservative method but it lacks reality sense then it
is not a good method. (Analysts may advise paying no more than $25 per share)
 Constant and Variable growth: both methods have similar stock price target,
but variable growth is more realistic since it measures shift up or down due to the
changing expectations. It is the most optimum ($43.98) not far from market value

TOMAS CLAUDIO COLLEGES

College of Business and Accountancy
Taghangin, Morong, Rizal

III. Conclusion

Based on the calculations, the firm’s current stock is still undervalued compare to
the value of stock with constant or variable growth. Zero growth calculation is
considered as not a good method because it will have changes in the future whether it
is increasing or declining/decreasing.

IV. Recommendation

In order to have growth in future dividend, Encore has to consider its financial plan
and the accompanying risk thoroughly.