Adjusted Present Value (APV)

Adjusted Present Value (APV)

The adjusted present value is the net present value (NPV) of a project or company if financed solely by equity plus the present value (PV) of any financing benefits, which are the additional effects of debt. The adjusted present value is the net present value (NPV) of a project or company if financed solely by equity plus the present value (PV) of any financing benefits, which are the additional effects of debt. The present value of the interest tax shield is therefore calculated as: (tax rate \debt load \* interest rate) / interest rate. To determine the adjusted present value: Adjusted Present Value = Unlevered Firm Value + NE where: NE = Net effect of debt \\begin{aligned} &\\text{Adjusted Present Value = Unlevered Firm Value + NE}\\\\ &\\textbf{where:}\\\\ &\\text{NE = Net effect of debt}\\\\ \\end{aligned} 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. While the adjusted present value method is similar to the discounted cash flow (DCF) methodology, adjusted present cash flow does not capture taxes or other financing effects in a weighted average cost of capital (WACC) or other adjusted discount rates.

APV is the NPV of a project or company if financed solely by equity plus the present value of financing benefits.

What Is Adjusted Present Value (APV)?

The adjusted present value is the net present value (NPV) of a project or company if financed solely by equity plus the present value (PV) of any financing benefits, which are the additional effects of debt. By taking into account financing benefits, APV includes tax shields such as those provided by deductible interest.

APV is the NPV of a project or company if financed solely by equity plus the present value of financing benefits.
APV shows an investor the benefit of tax shields from tax-deductible interest payments.
It is best used for leverage transactions, such as leveraged buyouts, but is more of an academic calculation.

The Formula for APV Is

Adjusted Present Value = Unlevered Firm Value + NE where: NE = Net effect of debt \begin{aligned} &\text{Adjusted Present Value = Unlevered Firm Value + NE}\\ &\textbf{where:}\\ &\text{NE = Net effect of debt}\\ \end{aligned} 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.

How to Calculate APV in Excel

An investor can use Excel to build out a model to calculate the net present value of the firm and the present value of the debt.

What Does Adjusted Present Value Tell You?

The adjusted present value helps to show an investor the benefits of tax shields resulting from one or more tax deductions of interest payments or a subsidized loan at below-market rates. For leveraged transactions, APV is preferred. In particular, leveraged buyout situations are the most effective situations in which to use the adjusted present value methodology.

The value of a debt-financed project can be higher than just an equity-financed project, as the cost of capital falls when leverage is used. Using debt can actually turn a negative NPV project into one that’s positive. NPV uses the weighted average cost of capital as the discount rate, while APV uses the cost of equity as the discount rate.

Example of How to Use Adjusted Present Value (APV)

In a financial projection where a base-case NPV is calculated, the sum of the present value of the interest tax shield is added to obtain the adjusted present value.

For example, assume a multi-year projection calculation finds that the present value of Company ABC’s free cash flow (FCF) plus terminal value is $100,000. The tax rate for the company is 30% and the interest rate is 7%. Its $50,000 debt load has an interest tax shield of $15,000, or ($50,000 * 30% * 7%) / 7%. Thus, the adjusted present value is $115,000, or $100,000 + $15,000.

The Difference Between APV and Discounted Cash Flow (DCF)

While the adjusted present value method is similar to the discounted cash flow (DCF) methodology, adjusted present cash flow does not capture taxes or other financing effects in a weighted average cost of capital (WACC) or other adjusted discount rates. Unlike WACC used in discounted cash flow, the adjusted present value seeks to value the effects of the cost of equity and cost of debt separately. The adjusted present value isn’t as prevalent as the discounted cash flow method.

Limitations of Using Adjusted Present Value (APV)

In practice, the adjusted present value is not used as much as the discounted cash flow method. It is more of an academic calculation but is often considered to result in more accurate valuations.

Learn More About Adjusted Present Value (APV)

To dig deeper into calculating the adjusted present value, check out Investopedia’s guide to calculating net present value.

Related terms:

Cost of Capital : Formula & Calculation

Cost of capital is the required return a company needs in order to make a capital budgeting project, such as building a new factory, worthwhile. read more

Cost of Equity

The cost of equity is the rate of return required on an investment in equity or for a particular project or investment. read more

Discounted Cash Flow (DCF)

Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. read more

Discount Rate

"Discount rate" has two distinct definitions. I can refer to the interest rate that the Federal Reserve charges banks for short-term loans, but it's also used in future cash flow analysis. read more

Free Cash Flow (FCF)

Free cash flow represents the cash a company can generate after accounting for capital expenditures needed to maintain or maximize its asset base. read more

Net Present Value (NPV)

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. read more

Payback Period

The payback period refers to the amount of time it takes to recover the cost of an investment or how long it takes for an investor to hit breakeven. read more

Pooled Internal Rate of Return (PIRR)

Pooled internal rate of return computes overall IRR for a portfolio that contains several projects by aggregating their cash flows. read more

Tax-Deductible Interest

Tax-deductible interest is a borrowing expense that a taxpayer can claim on a federal or state tax return to reduce taxable income. read more

Tax Shield

A tax shield is a reduction in taxable income by claiming allowable deductions such as mortgage interest and medical expenses. read more