Adjusted present value

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Adjusted Present Value (APV) is a business valuation method. APV is the net present value of a project if financed solely by ownership equity plus the present value of all the benefits of financing. It was first studied by Stewart Myers, a professor at the MIT Sloan School of Management and later theorized by Lorenzo Peccati, professor at the Bocconi University, in 1973.

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 case 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 DCF model. 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 formula

APV = Base-case NPV + PV of financing effect

The information suggests an APV calculation may change the rankings of the projects. APV is base case NPV +/- the side effects of financing. Here these are as follows: Base case NPV $3⋅60 Government grant $3⋅50 Interest rate benefit $0⋅62 ($7⋅75m x 0⋅02 x 0⋅70 x 5⋅747) APV = $7⋅72

Example

Given data

• Initial investment = 1 000 000
• Expected cashflow to equity = 95 000 in perpetuity
• Unlevered cost of equity = 10%
• Cost of debt = 5%
• Actual interest on debt = 5%
• Tax rate = 35%
• Project is financed with 500 000 of debt and 500 000 of equity; this capital structure is kept in perpetuity

Calculation

• Base-case NPV @10% = –1 000 000 + (95 000/10%)/(1 + 0.1) = –136 363 (approx)
• PV of Tax Shield @5% = (35% x 500 000 x 5%)/(1 + 0.05) = 8 333 (approx)
• APV = –136 363 + 8 333= -128 030

Note how substantial the effect of tax shield can be.

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