Closet Shelf, Inc. (CSI) is expected to pay a dividend of $2.00 at the end of this year, a $2.25 dividend at the end of year 2, and a $2.50 dividend at the end of year 3. It is estimated that its dividends will grow at a constant rate of 5 percent per year thereafter. If the required rate of return is 8 percent, the market value of CSI's common shares is closest to:

Question

Quizplus · Accepted Answer

The market value of the stock is calculated using the dividend discount model (DDM) for a stock with dividends growing at a constant rate. Calculate the present value of dividends for the first three years and the present value of the stock price at the end of year 3, which is calculated using the formula for a perpetuity growing at a constant rate. The sum of these present values gives the market value of the stock.