Boomer Products, Inc. manufactures "no-inhale" cigarettes. As its target customers age and pass on, sales of the product are expected to decline. Thus, demographics suggest that earnings and dividends will decline at a rate of 4% annually forever. The firm just paid a dividend of $2.50; given a required return is 12%, the price of the stock in two years will be:

Question

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To find the price of the stock in two years, we first need to calculate the dividend that will be paid in two years, and then use the Gordon Growth Model (also known as the Dividend Discount Model for a perpetuity) to find the price. The dividend in two years (D2) can be calculated as follows: D2 = D0 * (1 - g)^2, where D0 is the current dividend and g is the growth rate (as a negative in this case because it's a decline). So, D2 = $2.50 * (1 - 0.04)^2 = $2.50 * 0.9216 = $2.304. The price of the stock in two years (P2) can then be calculated using the formula P = D / (r - g), where D is the dividend in the following year (D3 in this case), r is the required return, and g is the growth rate. First, find D3: D3 = D2 * (1 - g) = $2.304 * (1 - 0.04) = $2.21184. Then, P2 = D3 / (r - g) = $2.21184 / (0.12 - (-0.04)) = $2.21184 / 0.16 = $13.82.