Question

Since adjusted present value(apv) of the proposed investment is made, discuss about the financial and non financial considerations given the APV.

Answer 1

APV (Adjusted Present Value) is a modified version of Net Present Value (NPV) that takes into account the PV of leverage effects separately. APV splits financing and non-financing cash flows and discounts them separately. Adjusted Present Value (APV) is used for the valuation of projects and companies. It takes the net present value (NPV), plus the present value of debt financing costs, which include interest tax shields, costs of debt issuance, costs of financial distress, financial subsidies, etc. The Adjusted Present Value approach takes into consideration the benefits of raising debts (e.g. interest tax shield), which NPV does not do. As such, APV analysis can be preferred in highly leveraged transactions.

Mathematically, APV = Unlevered value of the firm +Net effect of debt

The APV distinguishes the levered and unlevered cash flows and discounts them separately, that gives a more accurate depiction of costs of equity and debt and cash flows available.

APV can help managers analyze not only how much an asset is worth but also where the value comes from.Adjusted Present Value is an approach to investment appraisal that should be used if the financial risk of the company is expected to change significantly as a result of undertaking a project. Hence, it can be used if a new project has a different financial risk (debt-equity ratio) from the the overall capital structure of the company.

The value of a leveraged project may be higher than that of an all equity-financed project as the cost of capital often decreases with leverage, turning some negative NPV projects into positive ones. Thus, under the NPV rule, a project may be rejected but may be accepted if it is financed with some debt. Thus the Adjusted Present Value approach takes into consideration the benefits of raising debts.

Some assumptions while using APV:

=> The project’s risk is equal to the average risks of other projects within the firm, which is also the risk of the firm, as discussed above.
=> APV focuses only on the interest tax shields and ignore the effects generated by the costs of debt issuance and financial distress.
=> All debt is perpetual.

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