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 of 12%, the stock should today should sell for:

Question

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The stock price can be calculated using the Gordon Growth Model (Dividend Discount Model for declining dividends): P = D1 / (r - g), where D1 = D0 * (1 + g). Here, D0 = $2.50, g = -4% or -0.04, and r = 12% or 0.12. First, calculate D1 = $2.50 * (1 - 0.04) = $2.40. Then, P = $2.40 / (0.12 + 0.04) = $15.00.