Final answer:
To determine the value of a share of Babble, Inc., an investor must calculate the present value of future dividends using an appropriate discount rate, sum these present values, and divide by the number of shares, resulting in a price per share of approximately $256,500.
Step-by-step explanation:
The student's question involves dividend distribution calculations in a business context, specifically for a hypothetical company named Babble, Inc. This company is expected to issue dividends from its profits over a two-year period before being disbanded. Here is how an investor would calculate the price they might pay for a share of stock in this company:
To estimate the value of a share, investors need to determine the present value (PV) of the future dividends, which requires adjusting these future amounts for the time value of money. This is often done using a discount rate to reflect the investor's required rate of return. Once the present value of each dividend payment is calculated, these values are summed to arrive at the total present value of all future dividends. Finally, this total present value is divided by the number of shares to determine the price per share.
If Babble, Inc. is distributing profits of $15 million immediately, $20 million one year from now, and $25 million two years from now and plans to pay these out as dividends, the investor would first calculate the present value of each of these amounts separately, typically using a specific interest rate or required rate of return. For illustration, if a 15% discount rate is used for Babble, Inc., an investor would calculate the present value of each amount, add them together, and divide by the total number of shares, 200. The result would be approximately $256,500 per share.