What Is Adjusted Present Value (APV)?
Adjusted present value is a financial calculation that allows companies to compare different financing options to determine the best. The adjusted present value considers the tax benefits of taking on debt by including the calculations for interest paid. It consists of a project or company’s net present value (NPV) if financed solely by equity along with the present value (PV) of any financing benefits.
To calculate the APV, use the below formula
Adjusted Present Value = Unlevered Firm Value + Net effect of debt
The net effect of debt is the difference between a business’s debt and its cash. The amount of debt determines this, the interest accrued, and the tax benefits accrued with interest. To calculate this benefit, use interest expense * tax rate, which applies only one year of interest and tax.
The interest tax shield’s present value is calculated as (tax rate * debt load * interest rate) / interest rate.
How to Calculate Adjusted Present Value (APV)?
The APV is calculated using the following steps-
- Determine the value of the un-levered firm.
- Determine the net value of debt financing.
- To calculate the adjusted present value, you add up the value of the un-levered firm and the net value of the debt financing.
How to Calculate APV in Excel?
Using Microsoft Excel, an investor can build a model to determine the net present value of a firm and the present value of its debt.
What Does Adjusted Present Value Tell You?
When a business or person takes out a loan, their tax situation can be affected. When a business or person takes out a loan, their tax situation can be affected by the interest rate on an above-market basis. The adjusted present value helps you understand the benefits of deductions on interest payments or a subsidized loan at below-market rates.
The adjusted present value method is a valuable tool in analyzing leveraged transactions. Leveraged buyouts are a particular instance for which APV proves its worth.
Debt financing is often considered a bad decision, but that’s not always the case. Companies can use debt to lower the cost of capital, creating a more competitive advantage and turning a present negative value into a positive adjusted present value.
NPV and APV are fairly similar, the main difference being that NPV uses the weighted average cost of capital (WACC) as the discount rate while APV uses the cost of equity as the discount rate.
Example of How to Use Adjusted Present Value (APV)
Adjusted present value is used in financial projections, which are mainly based on a discount rate. It is derived by adding the net present value of the interest tax shield to the investment project.
For example, lets assume a multiple year projection calculation finds that the present value of XYZ company’s free cash flow (FCF) plus terminal value is $100,000. Considering the tax rate for the company is 20% and the interest rate is 6%. Its debt load is $50,000. So an interest tax shield is $10,000, or ($50,000 * 20% * 6%) / 6%. Thus, the adjusted present value is $110,000, or $100,000 + $10,000.
The Difference Between APV and Discounted Cash Flow (DCF)
The APV approach generally does not include taxes, financing effects, or other factors in the calculation of a project’s break-even point.
Unlike WACC used in discounted cash flow, the adjusted present value seeks to value the effects of the cost of equity and cost of debt separately because the two costs have a different impact on shareholder value. The adjusted present value is more often used by firms that possess substantial intangible assets and specialized knowledge.
Net Present Value vs. Adjusted Present Value
The NPV approach calculates the present value of future cash flows that include interest payments and repayments. Arguably the most popular cost of capital, WACC is an effective internal rate of return measure affected by financial distress. Furthermore, WACC discounts levered cash flows that may accrue to equity and debt holders.
APV helps investors understand their investment better since it brings information on levered and un-levered cash flows under one umbrella. As a result, it helps them devise a more accurate equity and debt financing structure based on the relevant cash flows for both equity and debt holders.
Limitations of Using Adjusted Present Value (APV)
The adjusted present value is rarely used in practice, as the discounted cash flow method is sufficient. The adjusted present value is seen as more of a theoretical calculation that provides more accurate valuations.
Applications of APV
- APV is a value measure that can be used to assess highly leveraged firms
- APV is also a widely used approach when an enterprise has financial distress.
- Firms having dynamic capital structures.
- Adjusted present value is a financial calculation that allows companies to compare different financing options to determine the best.
- Using Microsoft Excel, an investor can build a model to determine the net present value and the present value of its debt.
- The adjusted present value method is a valuable tool in analyzing leveraged transactions.
- NPV and APV are pretty similar, the main difference being that NPV uses the weighted average cost of capital (WACC) as the discount rate while APV uses the cost of equity as the discount rate.
- The APV approach generally does not include taxes, financing effects, or other factors in the calculation of a project’s break-even point.