Question

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).

Answer 1

Correct Answer: 1

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.