Jake Smith is an analyst at an investment advisory firm. Jake proposes to use a two-stage dividend discount model (DDM) to value the stock of the Essendon Company. Essendon currently pays an annual dividend of $1.25 per share. The stock is currently selling for $36 per share. Jake estimates that the dividend will grow at a rate of 12% per year for the next 3 years and then at 5% per year thereafter. The market risk premium is 5% and the annual risk-free rate is 4%. Based on Jake’s analysis, the beta of the Essendon stock is 1.4.

Jake uses the CAPM to calculate the cost of equity and then compute the two-stage DDM value of Essendon’s stock. 

What’s the price that Jake will get? Based on Jake’s estimation, please determine whether the Essendon stock is underpriced, fairly priced or overpriced.

Answer rating: 100% (QA)

Jake Smith the analyst at the investment advisory firm is using a twostage dividend discount model DDM to value the stock of the Essendon Company To c... View the full answer