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Adjusted Npv

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Adjusted present value
Wadia Haddaji February 20, 2008

• Topics: 1. Adjusted present value. • Readings: 1. Brealey, Myers and Allen, section 20.4.


The Adjusted-Present-Value Rule • Recall that we can write the value of a levered firm as the value of an otherwise identical all-equity firm and the value of its financing decisions: V = VU +NPV(financing decisions). • It is then obvious to define the APV of a project as the sum of its NPV to an all-equity firm and the PV of the associated financing decisions: APV = NPV(unlevered project) + NPV(financing decisions) • Separating the APV of a project into its NPV to an all-equity firm and the value of the associated financing decisions should be generally useful for the financial manager.


A Comparison of WACC and APV • Features/advantages of WACC. 1. WACC accounts for tax shield benefit of interest in discount rate. 2. WACC is widely adopted by practitioners and is easy to use. 3. WACC is applicable when D/E remains essentially constant through project life. 4. WACC is most appropriate when the project is “typical” of the firms traditional businesses (i.e., same risk), or “scale enhancing”. • Features/advantages of APV. 1. APV accounts for tax shield benefit of interest in cash flows (not discount rate). 2. APV was introduced by academics and is slowly being adopted in practice. 3. 11% of firms always or almost always use it. • APV often requires/accomodates knowledge of a particular debt repayment schedule. • APV (as opposed to WACC) is suited for situations where the debt to equity ratio is changing significantly over time (capital intensive projects and LBOs). • APV can handle “side effects”: tax shield, issue costs, bankruptcy costs, etc.

Adjusted Present Value: Example • Suppose the firm is evaluating a project requiring a $10 million investment and offering an after-tax free cash flow of $1.8 million per year…...

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