Adjusted present value (APV) is a valuation method introduced in 1974 by

Stewart Myers Stewart Clay Myers is the Robert C. Merton Professor of Financial Economics at the MIT Sloan School of Management. He is notable for his work on capital structure and innovations in capital budgeting and valuation, and has had a "remarkable influ ...

. The idea is to value the project as if it were all equity financed ("unleveraged"), and to then add the

present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...

of the

tax shield A tax shield is the reduction in income taxes that results from taking an allowable deduction from taxable income. For example, because interest on debt is a tax-deductible expense, taking on debt creates a tax shield. Since a tax shield is a way ...

debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...

– and other side effects. Technically, an APV valuation model looks similar to a standard DCF model. However, instead of WACC, cash flows would be discounted at the unlevered

cost of equity In finance, the cost of equity is the return (often expressed as a rate of return) a firm theoretically pays to its equity investors, i.e., shareholders, to compensate for the risk they undertake by investing their capital. Firms need to acquire cap ...

, and

s at either the

cost of debt In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate ne ...

(Myers) or following later academics also with the unlevered cost of equity. APV and the standard DCF approaches should give the identical result if the

capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is detailed in th ...

remains stable. According to Myers, the value of the levered firm (Value levered, Vl) is equal to the value of the firm with no debt (Value unlevered, Vu) plus the present value of the tax savings due to the tax deductibility of interest payments, the so-called value of the tax shield (VTS). Myers proposes calculating the VTS by discounting the tax savings at the

(Kd). The argument is that the risk of the tax saving arising from the use of debt is the same as the risk of the debt. The method is to calculate the NPV of the project as if it is all-equity financed (so called "base case"). Then the base-case NPV is adjusted for the benefits of financing. Usually, the main benefit is a

resulted from tax deductibility of interest payments. Another benefit can be a subsidized borrowing at sub-market rates. The APV method is especially effective when a

leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...

case is considered since the company is loaded with an extreme amount of debt, so the tax shield is substantial.

References

{{corporate finance and investment banking Valuation (finance) Financial models

See also

References