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b. Microsoft: MSFT
c. Weight Watchers: WTW Remember to check the book’s Web site at
for additional resources, including additional Web exercises. INTEGRATIVE CASE 2
n the world of trendsetting fashion, instinct and marketing savvy are
prerequisites to success. Jordan Ellis had both. During 2003, 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
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 of the securities analysts and the aggressive predictions
of the company founder, Jordan Ellis.
Marc has compiled these 2003 financial data to aid his analysis: I Data item
Earnings per share (EPS)
Price per share of common stock 2003 value
$40.00 Book value of common stock equity $60,000,000
Total common shares outstanding 350 2,500,000 Common stock dividend per share $4.00 Figure 1 Required Return, k (%) Security Market Line
30 Data Points
0 .5 1.0 1.5 2.0 2.5 3.0 Nondiversifiable Risk, b Required
a. What is the firm’s current book value per share?
b. What is the firm’s current P/E ratio?
c. (1) What are the required return and risk premium for Encore stock using
the capital asset pricing model, assuming a beta of 1.10? (Hint: Use the
security market line—with data points noted—given in Figure 1 to find
the market return.)
(2) What are the required return and risk premium for Encore stock using
the capital asset pricing model, assuming a beta of 1.25?
(3) What will be the effect on the required return if the beta rises as
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: Beta
e. (1) If 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: Beta 1.25.)
(2) 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? (Note:
f. Compare the current (2003) price of the stock and the stock values found in
parts a, d, and e. Discuss why these values may differ. Which valuation
method do you believe most clearly represents the true value of the Encore
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