Jordan Ellis' Case
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. The Encore shops are now a standard feature in every town in New Zealand.
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 shareholders 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 risk premium on its share, 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 share 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 2015 financial data to aid his analysis:
Data item 2015 value Earnings per share $ 6.25 Price per ordinary share $ 40.00 Book value of equity $ 60,000,000 Total ordinary shares outstanding 2,500,000 Ordinary dividend per share $ 4.00
Required:
a. What is the firm’s current book value per share? (2 Marks)
b. What is the firm’s current P/E ratio? (2 Marks)
(1) What is the current required rate of return for Encore’s shares?
(2) What will be the new required rate of return for Encore’s shares assuming that they expand into European and Latin American markets as planned? (6 Marks)
If the securities analysts are correct and there is no growth in future dividends, what will be the value per share? (Use the new required rate of return computed in part [C (2)] above). (2 Marks)
If Jordan Ellis’s predictions are correct, what will be the value per share if the firm maintains a constant annual 6% growth rate in future dividends? (Use the new required rate of return computed in part [C (2)] above). (2 Marks)
If Jordan Ellis’s predictions are correct, what will be the value per share if the firm maintains a constant annual 8% growth rate in dividends per share over the next 2 years and 6% thereafter? (Use the new required rate of return computed in part [C (2)] above)
Compare the current (2015) price of the share and the share values found in parts (a) to (e). Discuss why these values differ. Which valuation method do you believe most clearly represents the true value of Encore’s Share? (7 Marks)
B. Answer the following questions:
a. How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond. (5 Marks)