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The net present value (NPV) of a project or business if funded entirely by equity is added to the present value (PV) of any financing benefits, which are the additional impacts of debt. This is known as the adjusted present value. APV incorporates tax shelters like those offered by deductible interest by taking into account financing benefits.
Unlevered Firm Value plus NE equals Adjusted Present Value.
Calculating the adjusted present value involves:
- Find the unlevered firm’s worth.
- Determine the loan financing’s net worth.
- Add together the net value of the debt financing and the value of the unlevered project or business.
The adjusted present value aids in demonstrating to an investor the advantages of tax shelters brought on by one or more interest payment tax deductions or subsidized loans with interest rates below market. APV is preferred for transactions involving leverage. The most successful applications of the adjusted present value methodology are in leveraged buyout scenarios.
Due to the lower cost of capital when using leverage, the value of a project that is debt-financed may be higher than a project that is only equity-financed. A project with a negative NPV can become positive by using debt. While APV employs the cost of equity as the discount rate, NPV uses the weighted average cost of capital.
