Suppose XYZ Corp. is totally financed by equity; it is earning Rs. 2.50 per share; its capitalization rate is 20%. There are 10,000 shares outstanding, and the replacement cost of the firm's real assets is Rs. 1,25,000. XYZ Corp.'s value of Tobin's q is _______ (in integer).
Correct Answer: 1
Solution and Explanation
The value of Tobin's q is calculated as the ratio of the market value of a company's assets to the replacement cost of those assets. For XYZ Corp., this can be determined as follows:
1. Calculate the Market Value of the Firm
Since the firm is entirely equity-financed and earns Rs. 2.50 per share, we can use the market capitalization formula:
Market Value = Number of Shares × Price per Share
The firm's earnings per share (EPS) = Rs. 2.50, and the capitalization rate is 20% (0.20). Therefore, the price per share can be calculated by dividing the EPS by the capitalization rate:
Price per Share = EPS / Capitalization Rate = 2.50 / 0.20 = Rs. 12.50
With 10,000 shares outstanding, the total market value is:
Market Value = 10,000 × 12.50 = Rs. 1,25,000
2. Calculate Tobin's q
Tobin's q = Market Value of Assets / Replacement Cost of Assets
Given that the replacement cost of firm's real assets = Rs. 1,25,000, and the market value of those assets is also Rs. 1,25,000 as calculated:
Tobin's q = 1,25,000 / 1,25,000 = 1
Conclusion
The value of Tobin's q for XYZ Corp. is 1, which falls within the expected range of 1,1. Hence, the answer is correct and integer-based.
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