Adjusted Present Value (APV)

What Is an Adjusted Present Value (APV)?

Adjusted present value is a method for valuing an investment in two steps. First, it measures the value of the operating cash flows as if the project were paid for entirely with equity. Second, it adds the value of any effects that financing choices have on cash flows. This separates the value of the business itself from the value created or lost through borrowing and other financing decisions.

How It Works

The calculation begins with unlevered cash flow, the cash a business would generate with no debt. These cash flows are discounted at the unlevered cost of equity, which is the required return for a firm with no debt, to produce a base-case net present value. Next, the analyst adds the present value of financing side effects. The most common is the tax shield from interest, since interest payments reduce taxable income. Other side effects can include issuance costs for new securities, below-market loans, and expected costs of financial distress.

APV = Base-case NPV + PV of financing side effects

Because each component is valued separately, the analyst can see exactly where the value comes from.

Example

Consider a hypothetical project with a base-case NPV of 2 million dollars when financed only with equity. If the debt used to finance it is expected to produce tax savings with a present value of 300,000 dollars, the APV is 2.3 million dollars. Adding the tax benefit separately makes it clear how much of the total value depends on the debt.

Why It Matters to Investors

APV is often compared with valuations based on the weighted average cost of capital (WACC) used in discounted cash flow analysis. The WACC method builds the tax benefit of debt into the discount rate. That approach can be awkward when debt levels change over time. APV is often considered more flexible in such cases, such as a leveraged buyout where debt is repaid on a schedule. Its main drawback is that each financing effect must be estimated separately, which can be difficult and subjective. When reading a valuation, it helps to check which method was used and what assumptions sit behind the financing effects.