- Adjusted present value
Adjusted Present Value (APV) is a
business valuationmethod. APV is the net present valueof a project if financed solely by ownership equityplus the present valueof all the benefits of financing. Firstly, it was studied by Stewart Myers, a professor at the MIT Sloan School of Managementand then, in 1973, it was theorized by Lorenzo Peccati. Usually, the main benefit is a tax shieldresulted from tax deductibility of interest payments. Another one can be a subsidized borrowing. The APV method is especially effective when an LBOcase is considered since the company is loaded with an extreme amount of debt, so the tax shield is substantial.
Technically, an APV valuation model looks pretty much the same as a standard
DCFmodel. However, instead of WACC, cash flows would be discounted at the unlevered cost of equity, and tax shields at the cost of debt. APV and the standard DCF approaches should give the identical result if the capital structure remains stable.
APV value = Base-case NPV + PV of financing effect
*Initial investment = 1 000 000
*Expected cashflow = 95 000 in
*Unlevered cost of equity = 10%
*Cost of debt = 5%
*Actual interest on debt = 5%
*Tax rate = 35%
*Project is financed with 400 000 of debt and 600 000 of equity; this
capital structureis kept in perpetuity
*Base-case NPV = –1 000 000 + [95 000/10%] = –50 000
*PV of Tax Shield = [35% x [400 000 x 5%] / 5% = 140 000
*APV = –50 000 + 140 000 = 90 000, note how substantial the effect of tax shield can be.
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