Adjusted present value (APV)
Adjusted present value (APV), defined as the net present value of a project if financed solely by equity (so called base case) plus the present value of financing benefits. It is very similar to NPV. The difference is that it uses the cost of equity as the discount rate rather than weighted average cost of capital (WACC). APV includes tax shields by deductible interests. For adjusted present value (APV) approach, it shows the primary benefit of using borrowing from a tax benefit and the most significant cost of borrowing is the added risk of bankruptcy.
Adjusted Present Value = base case NPV + PV of financing
More explanations for APV calculation are as follows:
- Estimate the value of a company with no leverage by calculating base case NPV using cash flow from equity with the cost ofequityas the discount rate.
- Calculate the expected tax benefit from a given level of debt financing. Company may use the cost of debt or at a higher rate that reflects uncertainties about the tax effects. It is present value (PV) from financing.
- Evaluate the effect of borrowing the amount on the probability that the company will go bankrupt and the expected cost of bankruptcy.