Net Present Value Method
Internal Rate of Return Method
NPV vs IRR
Adjusted Present Value (APV) Method of Valuation is the net present value of a project if financed solely by equity (present value of un-leveraged cash flows) plus the present value of all the benefits of financing. Use this method for a highly leveraged project.
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Adjusted Present Value Method Calculation
1. Calculate the value of un-leveraged project by discounting the expected free cash flow to the firm at the un-leveraged cost of equity.
2. Then, calculate the expected tax benefit from a given level of debt by discounting the expected tax saving at the cost of debt to reflect the riskiness of this cash flow.
3. Finally, evaluate the effect of a given level of debt on the default risk of a company and expected bankruptcy costs.
Thus, the APV calculation is as follows:
Value of the operating assets = Un-levered firm value + PV of tax benefits – Expected Bankruptcy Costs
Adjusted present value = value of the operating assets + value of cash and marketable securities.
Adjusted Present Value Application
APV method is very similar to traditional discounted cash flow (DCF) model. However, instead of weighted average cost of capital(WACC), cash flows would be discounted at the cost of assets, and tax shields at the cost of debt. Technically, an APV valuation model combined impact of both growth and the tax shield of debt on the cost of capital, the cost of equity, and systematic risk. Thus it is a more flexible way of approaching valuation than other method. However, APV method has some flaws. Company value will be overstated when adding the tax benefits to un-levered company value to get the levered company value, especially for some companies with high debt ratios.
Take some time to read over our Top 10 Destroyers of Value whitepaper before you start your company’s valuation.
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