Adjusted Present Value (APV)
What Is Adjusted Present Value (APV)?
The adjusted present value is the net present value (NPV) of a project or company whenever financed exclusively by equity plus the current value (PV) of any financing benefits, which are the unexpected effects of debt. By considering financing benefits, APV incorporates tax shields like those given by deductible interest.
The Formula for APV Is
The net effect of debt incorporates tax benefits that are made when the interest on a company's debt is tax-deductible. This benefit is calculated as the interest expense times the tax rate, and it just applies to one year of interest and tax. The current value of the interest tax shield is thusly calculated as: (tax rate * debt load * interest rate)/interest rate.
Instructions to Calculate Adjusted Present Value (APV)
To decide the adjusted present value:
- Find the value of the un-turned firm.
- Ascertain the net value of debt financing.
- Sum the value of the un-turned project or company and the net value of the debt financing.
The most effective method to Calculate APV in Excel
An investor can utilize Excel to build out a model to compute the net present value of the firm and the current value of the debt.
What Does Adjusted Present Value Tell You?
The adjusted present value assists with showing an investor the benefits of tax shields coming about because of at least one tax deductions of interest payments or a sponsored loan at below-market rates. For leveraged transactions, APV is preferred. Specifically, leveraged buyout circumstances are the best circumstances wherein to utilize the adjusted present value methodology.
The value of a debt-financed project can be higher than just an equity-financed project, as the cost of capital falls when leverage is utilized. Utilizing debt can really transform a negative NPV project into one that is positive. NPV involves the weighted average cost of capital as the discount rate, while APV involves the cost of equity as the discount rate.
Illustration of How to Use Adjusted Present Value (APV)
In a financial projection where a base-case NPV is calculated, the sum of the current value of the interest tax shield is added to get the adjusted present value.
For instance, assume a long term projection calculation observes that the current value of Company ABC's free cash flow (FCF) plus terminal value is $100,000. The tax rate for the company is 30% and the interest rate is 7%. Its $50,000 debt load has an interest tax shield of $15,000, or ($50,000 * 30% * 7%)/7%. Subsequently, the adjusted present value is $115,000, or $100,000 + $15,000.
The Difference Between APV and Discounted Cash Flow (DCF)
While the adjusted present value method is like the discounted cash flow (DCF) methodology, adjusted present cash flow doesn't capture taxes or other financing effects in a weighted average cost of capital (WACC) or other adjusted discount rates. Dissimilar to WACC utilized in discounted cash flow, the adjusted present value looks to value the effects of the cost of equity and cost of debt separately. The adjusted present value isn't so pervasive as the discounted cash flow method.
Limitations of Using Adjusted Present Value (APV)
In practice, the adjusted present value isn't utilized as much as the discounted cash flow method. It is a greater amount of a scholarly calculation yet is frequently considered to bring about additional accurate valuations.
More deeply study Adjusted Present Value (APV)
Features
- APV is the NPV of a project or company whenever financed exclusively by equity plus the current value of financing benefits.
- APV shows an investor the benefit of tax shields from tax-deductible interest payments.
- It is best utilized for leverage transactions, like leveraged buyouts, however is a greater amount of a scholarly calculation.
