Adjusted Present Value (APV)
Meaning and definition of adjusted present value
The Adjusted Present Value (APV) can be delineated as the Net Present Value of a project, financed exclusively by equity, added to the Present Value (PV) of any financing benefits (the added effects of debt). As explained by Investopedia, taking the financing benefits into account, the Adjusted Present Value consists of tax shields like those proffered by deductible interests.
Application of Adjusted Present Value
The APV method is quite similar to conventional Discounted Cash Flow system. However, rather than WACC, cash flows are discounted at the assets’ cost, and tax shields at the debt’s cost. Theoretically, the APV method brings together the impact of growth as well as the tax shield of debt on the cost of equity, systematic risk, and cost of capital. Therefore, it comes up to be a more flexible technique to approach valuation as compared to other methods.
Calculating the Adjusted Present Value
Adjusted present value can be referred as a financial measurement used for determining an investment’s worth. Generally, it delineates the prospective profitability of a project by evaluating the current amount of cash inflows and contrasting it to the current amount of cash outflows. The main steps involved in calculating the Adjusted Present Value include:
- Determine the base net present value of the project. This is done by estimating the cost of equity, project’s life, the initial cost of the project, and the cash flow for a minimum of one year of operation.
- Calculate the present value of the financing effect by estimating the amount of debt that will be incurred for the project, the project cost, the interest rate on the debt and the tax rate. After this info has been gathered, put the data into the following formula for calculating the present value of the financing effect.
Financing effect = (Tax Rate X Debt Incurred X Cost of Debt) / Interest Rate of Debt
- As a final step, add the base net value to the present value of the financing effect thus receiving the sum of two numbers as the adjusted present value.