Adjusted Present Value (APV): What Is It?

If funded entirely by equity, the net present value (NPV) of a project or business is added to the present value (PV) of any financing benefits, which are the additional impacts of debt. This is known as the adjusted present value. APV incorporates tax shelters like those offered by deductible interest by considering financing benefits.

The Formula for APV Is

Adjusted Present Value = Unlevered Firm Value + NEwhere: NE = Net effect of debt​Adjusted Present Value = Unlevered Firm Value + NEwhere:NE = Net effect of debt

The net effect of debt includes tax benefits that are created when the interest on a company’s debt is tax-deductible. This benefit is calculated as the interest expense times the tax rate, and it only applies to one year of interest and tax. The present value of the interest tax shield is therefore calculated as: (tax rate * debt load * interest rate) / interest rate.

How to Calculate Adjusted Present Value (APV)

To determine the adjusted present value:

1. Find the value of the un-levered firm.
2. Calculate the net value of debt financing.
3. Sum the value of the un-levered project or company and the net value of the debt financing.

Excel APV Calculation Instructions

An investor can use Excel to construct a model that determines the company’s net present value and the debt’s present value.

What Can You Infer from the Adjusted Present Value?

The adjusted present value aids in demonstrating to an investor the advantages of tax shelters brought on by one or more interest payment tax deductions or subsidized loans with interest rates below market. APV is preferred for transactions involving leverage. The most successful applications of the adjusted present value methodology are in leveraged buyout scenarios.

Due to the lower cost of capital when using leverage, the value of a debt-financed project may be higher than that of only an equity-financed project. A project with a negative NPV can become positive by using debt. While APV employs the cost of equity as the discount rate, NPV uses the weighted average cost of capital.

Use of Adjusted Present Value (APV) Example

The present value of the interest tax shield is added to the base-case NPV in a financial projection to produce the adjusted present value.

Assume, for instance, that a calculation of a multi-year projection reveals that Company ABC’s free cash flow (FCF) plus terminal value has a present value of $100,000. The business’s tax rate is 30%, and its interest rate is 7%. Its interest tax shield on its $50,000 debt load is $15,000, or ($50,000 * 30% * 7%) / 7%. Therefore, the adjusted present value, or $100,000 plus $15,000, is $115,000.

The Distinction Between Discounted Cash Flow (DCF) and APV
The discounted cash flow (DCF) technique and the adjusted present value approach are similar. Still, the adjusted present cash flow method does not account for taxes or other financing implications in a weighted average cost of capital (WACC) or other adjusted discount rates. In contrast to WACC, which is employed in discounted cash flow, the adjusted present value aims to value the effects of the cost of equity and the cost of debt separately. The discounted cash flow method is more common than the adjusted present value approach.

Adjusted Present Value (APV) Limitations
The discounted cash flow method is more commonly utilized in real-world situations than the adjusted present value. Although it is more of an intellectual calculation, it is frequently believed to produce more accurate valuations.

Conclusion

• The net present value (NPV) of a project or business, plus the present value of financing benefits, is the APV.
  An investor can see from APV the advantages of tax shelters from interest payments that are tax deductible.
• It is more of an intellectual calculation, although it works well for leveraged deals like buyouts.