Final answer:
An investor will pay for a share of stock in Babble, Inc. based on the present value of the expected future dividends. The investor should calculate the present value of these future dividends by discounting them using a rate of return. Solving the equation will give the investor the price they should pay for a share of stock.
Step-by-step explanation:
An investor will pay for a share of stock in Babble, Inc. based on the present value of the expected future dividends. In this case, the company is expected to have profits of $15 million right away, $20 million one year from now, and $25 million two years from now. Since the company will be disbanded in two years and all profits will be paid out as dividends, the investor should calculate the present value of these future dividends to determine the price of a share of stock.
To calculate the present value, the investor needs to discount the future dividends by a rate of return. Let's assume a rate of return of 10% for this example. Using the formula for present value of cash flows, the investor can determine the price of a share of stock:
Price of Stock = [($15 million / (1 + 0.10)^1) + ($20 million / (1 + 0.10)^2) + ($25 million / (1 + 0.10)^3)] / 200
Solving this equation will give the investor the price they should pay for a share of stock in Babble, Inc.