Question

You recently met with the owners of the client company and noted the following transactions that occurred during the 2022 fiscal year:

1. During 2022, LBE sold 100 warranties for $5,000 each on its high-end bathtubs. The warranty period is five years. Historically, the warranties have resulted in a cost of approximately $500 each per year. LBE uses the cash basis to recognize the warranty expense and revenue. During 2022, no warranty costs were incurred.
2. On December 31, 2022, LBE was notified that it will need to perform a cleanup every ten years of the area surrounding its manufacturing plant. LBE estimated that the costs of the cleanup will be approximately $750,000 in ten years. Stanley indicated that, because the amount is not due for years, there is no need to recognize anything at this point.
3. On January 1, 2022, LBE bought inventory. The purchase was financed through an interest-free vendor take-back loan, with a promise to repay $200,000 in two years. David recorded the loan on the balance sheet at $200,000. As at December 31,2022 , the inventory's net realizable value was $100,000.
4. On June 30, 2022, an employee launched a wrongful dismissal suit against LBE for $125,000. LBE's lawyers have indicated that they expect a payment of $100,000 to $115,000, but the lawsuit is still in court proceedings. David did not recognize any amount for this because he believes that LBE will be able to successfully defend the suit.
5. On December 31,2022 , LBE issued 10,000 redeemable and retractable preferred shares at $50 per share, for tax planning purposes. The shares are redeemable and retractable at any date up to December 31, 2027, at which point the redeemable and retractable features expires. The preferred shares pay a mandatory dividend of $10 per share per year until the end of the redeemable and retractable period, after which the dividends are not cumulative and not mandatory. David recorded these shares as equity, and the first dividend payment on December 31,2022 , was recorded through equity.

Answer 1

An investor would calculate the present value of expected dividends from Babble, Inc. using a 15% interest rate and then divide the total by the number of shares, resulting in an estimated share price of $256,500.

Step-by-step explanation:

To determine what an investor would pay for a share of stock in Babble, Inc., we need to calculate the present value (PV) of the dividends expected to be received in the next two years. As profits are paid immediately and in the following two years, we must also take into account any interest rate to calculate the present value of the future dividends. Assuming a 15% interest rate, we calculate the present value for each year's profits and then add them up to find the total present value of all future payouts.

For immediate profits of $15 million, the present value is simply $15 million, since there is no time delay. For the $20 million expected in one year, the present value (PV) would be $20 million divided by (1 + 0.15)1, and for the $25 million in two years, the present value would be $25 million divided by (1 + 0.15)2. Once we have these values, we sum them up and then divide by the total number of shares, which is 200, to find out how much an investor might be willing to pay for each share.

Calculating this, and assuming the totals yield a sum of $51.3 million of present value for all future payouts, we then divide this by 200 to find the price per share. Hence, an investor should be willing to pay about $256,500 per share.