Final answer:
To calculate the price an investor might pay for a share in Babble, Inc., the future dividends are taken into account. Each year's expected profit is divided by the number of shares and then discounted to present value at an assumed rate of return. By summing the present values of these dividends, the maximum price an investor may pay for a share can be estimated.
The statment is true.
Step-by-step explanation:
To determine the price an investor might pay for a share of stock in Babble, Inc., a company that offers speaking lessons, one must consider the future dividends the stock will provide.
The shareholders are expected to receive profits in the form of dividends, which for Babble, Inc. are $15 million immediately, $20 million in one year, and $25 million in two years.
As the company is issuing 200 shares, each share would ostensibly receive equal portions of the profit. Therefore, to calculate the price per share, we divide each year's profit by the number of shares and then calculate the present value of these future payments using a reasonable rate of discount.
Assuming an investor uses a discount rate (which represents the expected rate of return) to bring future dividend payments to present value terms, each sum can be calculated using the formula for present value of a future payment:
Present Value = Future Payment / (1 + r)^n
where 'r' represents the discount rate, and 'n' represents the number of years in the future the payment will be received. By summing the present values of all expected dividends, an investor can determine the maximum price they are willing to pay for a share today.
For example, if the rate of return expected is 10% (0.10), the present value of the profits for each share would be calculated as follows:
Year 0 (Immediate): $15,000,000 / 200 shares = $75,000 per share with no discount as it is immediate
Year 1: $20,000,000 / 200 shares / (1 + 0.10) = $90,909.09 per share
year 2: $25,000,000 / 200 shares / (1 + 0.10)^2 = $103,305.79 per share
The total value of all dividends is the sum of these three values. Thus, an investor might be willing to pay up to the total present value to acquire one share of Babble, Inc., assuming a 10% discount rate.
This example does not factor in any market conditions, risk assessment, tax implications, or company-specific considerations which may further affect the investment decision.
The statment is true.