Question

How to calculate the value of the firm by using the APV method?

Answer 1

Step 1

Calculate the value of the unlevered firm or project (VU), i.e. its value with all-equity financing. To do this, discount the stream of FCFs by the unlevered cost of capital (rU).

Step 2

Calculate the net value of the debt financing (PVF), which is the sum of various effects, including:

•       PV(Interest tax shields) – our main focus
•       PV(Issuance costs)
•       PV(Financial distress costs)
•       PV(Other market imperfections)

Step 3

Sum up the value of the unlevered project and the net value of debt financing to find the adjusted present value of the project. That is, VL = VU + PVF.

Formula of AVP = Unlevered firm value + Net effect of debt