Why should tobin’s q return to 1 ?
can anyone explain the note 📝 thing esp the economic rents or profits part ?
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The market value of debt and equity is the value of the firm as a going concern, it includes expected future profits as well. It includes the synergy among the assets, the value because of the management, and the value of the brand.
On the other hand, the replacement cost simply considers the amount that can be realised if all assets and liabilities are settled today individually. It does not consider synergies, management or value of the inherent brand.
The reasons are similar to why the P/B ratio is not equal to 1.
As for the note, Tobin says that since, in the long run, no company will earn economic profit or residual income (profit in excess of what is required by investors) the market value should approach the replacement cost, so the ratio should approach 1. (Just like P/B).
The reason is that, if a company is earning supernormal profits, other firms will try to enter the industry, increasing competition and wiping out the economic profits.
Hope this helps!