Understanding Q Theory of Investment in Economics
Learn about the Q theory of investment, which relates to how stock market values influence financing decisions for firms. Discover how managers respond to market conditions and the significance of the Q ratio in estimating a firm's value relative to capital costs.
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Presentation Transcript
Q THEORY OF INVESTMENT Presented by:- LALIT CHANDRA DOLEY V.P. & Associate Professor, Dept. of Economics, Silapathar College, Silapathar.
The The Q Q theory the Nobel Nobel Prize relates the the stock stock market raise raise finances finances for through through the the sale sale of of shares equities, equities, expect expect to to receive the the rise rise in in market market values shares shares sold sold out out by capital capital of of the the company company. . theory of of investment Prize winner market to to investment for investment investment not shares or or equities receive a a return values of of their by the the company company represent investment is is associated winner James James Tobin investment. . A A firm not through through borrowing equities. . The The people, return from from dividends dividends and/or their holdings holdings of of equities represent a a claim associated with Tobin. . This firm may may decide borrowing but people, who and/or from equities. . The claim on with the This theory theory decide to to the name name of of the relates but buy from The on the who buy the
When the price of a share in the market is high, the managers of the company respond to the higher price of the stock by producing more new capital, i.e., they undertake larger investment because they are, in such a situation, able to raise a lot of money through the disposal of relatively smaller quantity of shares. The owners of the firm, the existing share holders, will be more inclined that the firm acquires more money by selling a larger quantum of equities. It is expected that the firm will actually decide to sell more equities for financing investment, when the stock market is high than in the opposite situation of low share prices.
In the conditions of falling equity prices, the buyers have little desire to buy the shares. The managers of the company will find difficult to raise sufficient funds for financing depressing conditions existing in the stock market make the managers to postpone the sale of equities and consequently there investment. investment. The is little prospect of
The most pertinent question in regard to this theory is :What is Q? Q may be defined as an estimate of the value of the stock that the market places on firm s assets relative to the cost of creating those assets. In other words, Q signifies the ratio of the market value of a firm s stock to the replacement cost of capital. Q = MarketValue of Stock Replacement Cost of Capital
When the ratio Q is high, the firm will be inclined to produce more assets, so there will be rapid investment and vice-versa. Whenever Q is greater than unity, a firm should make addition to the physical capital because for each dollar s worth of new machinery the firm can dispose of stock for Q dollars and secure a profit (Q-l).Thus, there can be the possibility of flood of investment whenever Q greater than unity. In reality, such a possibility may however, not arise on account of necessity of making cost adjustment and there may be only a moderate rise in investment with a rise in Q. *******
