Adjusted present value (APV) is a
valuation method introduced in 1974 by
Stewart Myers. 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 (PDV), 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 ha ...
of the
tax shield of
debt
Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Co ...
– 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 ca ...
, and
tax shields at either the
cost of debt (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 the ...
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
cost of debt (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
tax shield 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 the acquisition of a company using a significant proportion of borrowed money (Leverage (finance), leverage) to fund the acquisition with the remainder of the purchase price funded with private equity. The assets of t ...
case is considered since the company is loaded with an extreme amount of debt, so the tax shield is substantial.
See also
*
Leverage (finance)
In finance, leverage, also known as gearing, is any technique involving borrowing funds to buy an investment.
Financial leverage is named after a lever in physics, which amplifies a small input force into a greater output force. Financial leverag ...
*
Hamada's equation
References
{{corporate finance and investment banking
Valuation (finance)
Financial models