Final answer:
An investor would calculate the present value of expected dividends to determine the share price for Babble, Inc. stock. Using a discount rate equal to the current T-bills yield, the dividends for each year would be discounted back to their present values and then summed to find the total present value per share.
Step-by-step explanation:
Valuing a Stock Based on Dividend Payouts
To determine what an investor would pay for a share of stock in Babble, Inc., we must calculate the present value of the expected dividends, which represent the cash flows an investor will receive. Given that the profits will be disbursed as dividends and the company will be disbanded in two years, we can use the dividend discount model (DDM). To find the present value of these dividends, we discount them back to their present value using a given rate of return, which could be the yield currently offered by risk-free investments such as T-bills.
Assuming the T-bills yield is a suitable discount rate, let's calculate the present value (PV) for each year's expected dividend:
Once all the dividends are discounted to their present values, we would add them up to get the total present value of the stock per share. This would be the price an investor is likely to pay for a share of Babble, Inc.
Note that when interest rates rise, bonds previously issued at lower interest rates will sell for less than face value. Conversely, when interest rates fall, bonds previously issued at higher interest rates will sell for more than face value. This also applies to stocks to some extent, as alternative investment returns (like those from bonds) can impact stock valuation.