Tobin's Q is a ratio that compares the market value of a firm to the replacement cost of its assets. Specifically, it is defined as:
When , it suggests that the market values the firm higher than the cost to replace its assets, indicating potential opportunities for investment and expansion. Conversely, when , it implies that the market values the firm lower than the cost of its assets, which can discourage new investment. This concept is crucial in understanding investment decisions, as companies are more likely to invest in new projects when Tobin's Q is favorable. Additionally, it serves as a useful tool for investors to gauge whether a firm's stock is overvalued or undervalued relative to its physical assets.
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