APV (Adjusted Present Value) Method is one of calculation methods of present value of cash flow. In this method, present value is firstly calculated given future cash flow is generated without debt and secondly increase in cash flow by tax shield generated by debt is added to former one.
In WACC Method, tax shield is already included into formula, but in APV Method, it is separately calculated.
An exapmle of APV
The following is an example of APV.
Investment cost@@100K USD
Free Cash Flow@@20K USD / Y
Discount rate@10% (without debt)
In this situation, NPV is under zero so this investment is not valuable for a company.
By the way, in this calculation, Unlevered Beta is used because this business is run without debt.
Effect of tax shield
If all investment cost is born by debt in above situation, tax shield needs to be estimated. If 10K USD is returned by a year, tax shield of each year is as below.
Remain of Debt
As a result of estimation, present value of tax shield is 6.9K USD, which means this investment is valuable for the company.
Discount rate of tax shield
In this example, debt cost is used for discount rate of tax shield. If tax shield is affected by only debt cost, it would be no problem. However, Unlevered Beta also can be applied for tax shield if tax shield is affected by business risk because tax shield is not effective unless the company get profit.
Advantages of APV
Present value can be calculated in case of significant D/E ratio change
APV is used when D/E ratio significant changes like LBO or turnaround because present value of tax shield can be estimated apart from that of business.
Factors of NPV is visible
Each factor affecting NPV can be discussed by using APV method because each factor is visible.
Disadvantages of NPV
APV makes us clarify value of tax shield but financial risk with increase in debt is not considered
WACC includes this financial risk because increase in D/E ratio brings increase in Beta. However, in APV Method, only business risk is considered because Unlevered Beta is used instead of Beta.
Therefore, APV should be used given debt risk hardly affect business risk or customized APV formula should be used as below.
NPV = NPV without debt + Tax shield - financial risk (this is equivalent of Beta in WACC Method)
Principle of Finance FCF (Free Cash Flow) DCF (Discount Cash Flow) WACC Beta Unlevered Beta IRR Terminal Value Disadvantages of WACC APV (Adjusted present value) Method
Making Portfolio and Diversification of Risk 1
Making Portfolio and Diversification of Risk 2
Return analysis by DCF 1
Return analysis by DCF 2
Important Indicator of DCF
Optimized Debt Equity Ratio
Tax Shield by Debt
Types of Debt
Policy of Dividend
Relationship between Policy of Dividend & Stock Price
Relationship between Own Shares Purchase & Stock Price
Investment to raise Stock Price
Bond with Warrant
Comparison of Yield Rate among Several Bonds
Effect of M&A
Financing in M&A
Process of Purchasing Stock Price in M&A
Types of Selling Business
LBO (Leveraged Buy Out)
MBO (Management Buy Out)
PPA (Purchase Price Allocation)
PMI (Post Merger Integration)