Discussion
Tobin's q-theory of investment indicates that firms add to their stock of capital when
Answer: B
Tobin's q is the ratio of the market value of a firm's capital to its replacement cost. When q is above one, a unit of installed capital is worth more than it costs to build, so firms add to their capital stock. The keyed option is that the market value of their financial assets, meaning the firm's equity and debt claims on its real capital, exceeds the replacement value of their real assets. Option A reverses the inequality, which would make investment unprofitable. Options C and D compare the market value with a book value, but the theory concerns replacement cost, not accounting book value.
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