Integrative Case:-
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 youfirwoman froth 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 as-signed 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 the following 2015 financial data to aid his analysis.
| Data item |
2015 value |
| Earning 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 |
TO DO
a. What is the firm's current book value per share?
b. What is the firm's current P/E ratio?
c. (1) What is the current required return for Encore stock?
(2) 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.)
Spreadsheet Exercise:-
The Drillago Company is involved in searching for locations in which to drill for oil. The firm's current project requires an initial investment of $15 million and has an estimated life of 10 years. The expected future cash inflows for the project are as. shown in the following table.
| Year |
Cash inflows |
| 1 |
$600,000 |
| 2 |
1,000,000 |
| 3 |
1,000,000 |
| 4 |
2,000,000 |
| 5 |
3,000,000 |
| 6 |
3,500,000 |
| 7 |
4,000,000 |
| 8 |
6,000,000 |
| 9 |
8,000,000 |
| 10 |
12,000,000 |
The firm's current cost of capital is 13%.
TO DO:-
Create a spreadsheet to answer the following questions.
a. Calculate the project's net present value (NPV). Is the project acceptable under the NPV technique? Explain.
b. Calculate the project's internal rate of return (IRR). Is the project acceptable under the IRR technique? Explain.
c. In this case, did the two methods produce the same results? Generally, is there a preference between the NPV and IRR techniques? Explain.
d. Calculate the payback period for the project. If the firm usually accepts projects that have payback periods between 1 and 7 years, is this project acceptable?