Question

Show or write the Tobin’s formula and explain how it would be different from the market to book value ratio. Explain some uses for it in business decision making such as buying or selling a company. Include in your discussion, the impact intangible assets.

Answer 1

How Tobin’s formula different from the market to book value ratio.

Tobin's q ratio is can be defined as the market value of the company/replacement value of the company's assets.  Market to book value ratio is the market value of the company/book value.
We can see that the numerator in both ratios (market value) is the same. The difference is the denominator, which is replacement value for Tobin's q and book value for Market value/book ratio. So the question is how book value differ from replacement cost?"
Replacement cost and Book value are two methods of measuring the value of the same item, an important difference is that Book value is calculated on basis of the original cost of buying the asset .It takes into account wear and tear by subtracting depreciation and amortization on the other side Replacement cost is the cost of replacing the items at their pre-loss condition right now. Book value was valued at lower, pre-inflation prices of buying the assets whereas replacement cost takes account of inflation which makes replacement cost higher than the book value. So during times of inflation book value will be less than replacement cost.

Uses for Tobin’s formula and intangible assets

A low Tobin's q ratio (value of q in between 0 and 1) means that the cost to replace a firm's assets is greater than the value of its stock. It means the company is undervalued. On the other side a higher Q (value of q greater than 1) implies that a company's stock is more expensive than the replacement cost of its assets, which makes the company is overvalued. An undervalued company, one with a low Tobin's q ratio of less than one, would be attractive to potential purchasers.

Finding the replacement cost of intangible assets is a difficult task even if you arrived at a value it is sometimes very difficult to justify them.