Adjusted Present Value - Explained
What is Adjusted Present Value?
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Table of ContentsWhat is Adjusted Present Value?How Does Adjusted Present Value Work?Calculation of Adjusted Present Value - APVExample of How to Use Adjusted Present Value APVAPV vs Discounted Cash FlowDrawbacks of using Adjusted Present Value
What is Adjusted Present Value?
Adjusted Present Value refers to the sum of net present value of an organization or a project that is totally based on equity financing and present value of financing advantages, if any. These financial benefits, when considered, provide tax cushions (for example: deductible interest) to adjusted present value.
APV Formula = Unlevered Firm Value + Net Debt Effect
Back to:BUSINESS & PERSONAL FINANCE
How Does Adjusted Present Value Work?
Net effect of debt consists of the following factors:
- Interest tax shield which is formed for companies in debt as the interest on debt is considered to be tax-deductible. It is ascertained by multiplying interest expense with rate of tax provided. It involves the interest tax shield only for that specific year.
- The next thing to consider is the present value of interest tax shield. The present value of interest tax shield is calculated as follows:
(tax rate * debt load * interest rate) / interest rate
Calculation of Adjusted Present Value - APV
For ascertaining the Adjusted Present Value,
- Ascertain the worth of unlevered organization
- Then compute net value of debt financing
- Add the value of unlevered organization calculated in step 1 and net value of debt financing calculated in step 2
The adjusted present value tells an investor about the advantages of tax shields occurring from at least one tax deductions of interest expenses or a subsidized loan set at rates below market rates. APV appears to be more reliable and preferable for carrying out leveraged buyout transactions. Because of the cost of capital declining with more utilization of leverage, the worth of a project financed on debt is more than the one financed on equity. Debt, if properly used, can convert any project with a negative net present value to a positive one. NPV considers cost of equity as the discount rate, while in case of APV, weighted average cost of capital is considered as discount rate.
Example of How to Use Adjusted Present Value APV
For arriving at the adjusted present value, the total of present value of interest tax shield is included at the time of making financial estimates. For instance, the present value of a company's free cash flow and its terminal value is $100,000. The interest rate is 7% and tax rate is 30%. The debt load is of $50,000 and it carries an interest tax shield of $15,000 ($50,000 * 30% * 7%) / 7%). Therefore, APV will be $115,000, that is the sum of FCF and terminal value and interest tax shield ($100,000 + $15,000).
APV vs Discounted Cash Flow
Though there is not much difference between adjusted present value and discounted cash flow, adjusted present cash flow does not include taxes or any other financing impacts in a weighted average cost of capital (WACC). While WACC is applied in discounted cash flow, the adjusted present value measures the effects of cost of debt and cost of equity in an independent manner. The adjusted present value is less significant as compared to discounted cash flow method.
Drawbacks of using Adjusted Present Value
Generally, the adjusted present value is less frequently used as discounted cash flow method. It can consist of more calculations, but the valuation is more appropriate and clearer in nature.