The Q Theory of Investmen

In: Business and Management

Submitted By jennylu
Words 3076
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McDonald / J Zhejiang Univ SCI 2004 5(5):499-508

499

Journal of Zhejiang University SCIENCE ISSN 1009-3095 http://www.zju.edu.cn/jzus E-mail: jzus@zju.edu.cn

The Q theory of investment, the capital asset pricing model, and asset valuation: a synthesis
MCDONALD John F.
(College of Business Administration, University of Illinois at Chicago, Chicago, USA) E-mail: mcdonald@uic.edu Received Feb. 23, 2004; revision accepted Mar. 6, 2004

Abstract: The paper combines Tobin’s Q theory of real investment with the capital asset pricing model to produce a new and relatively simple procedure for the valuation of real assets using the income approach. Applications of the new method are provided. Key words: Investment theory, Asset pricing, Appraisal Document code: A

CLC number:

F832.48

INTRODUCTION This paper combines the economic theory of real investment and the standard financial model of asset pricing to produce a method for the valuation of real assets; and intentionally uses relatively simple versions of these two theories to link economics, finance, and appraisal. Numerical examples using data on real estate assets illustrate the valuation method. The Q theory of investment, introduced by James Tobin (1969), is popularly accepted theory of real investment hypothesized to be a positive function of Q, defined as the ratio of the market value to the replacement cost of capital. Standard presentation of the theory, such as that of Romer (1996), shows that Q is the value to the firm of an additional unit of capital, which is the discounted value of its future marginal revenue products. Extensions of the Q theory of investment have added uncertainty about future returns. An important article by Craine (1989) examines the effect of total risk on the allocation of capital in a simple general equilibrium

model; with the result that an exogenous increase in…...

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