1.4 Impact of financing on investment decisions – the concept of adjusted present value (APV)

The concept of Adjusted Present Value (APV) is a financial valuation method that incorporates the impact of financing choices on investment decisions. It recognizes that different financing options, such as debt or equity, can affect the cash flows and value of an investment project.

The APV approach involves adjusting the present value of cash flows by adding or subtracting the effects of financing decisions. The basic steps involved in applying APV are as follows:

1. Calculate the unleveraged (all-equity) value of the investment project: This involves discounting the expected cash flows of the project at the appropriate discount rate, assuming the project is financed entirely with equity.
2. Determine the tax shield value of debt financing: Debt interest payments are tax-deductible, which creates a tax shield benefit. Calculate the present value of the tax shield by multiplying the tax rate by the interest expense and discounting it at the appropriate discount rate.
3. Incorporate the effects of other financing choices: Additional financing options, such as preferred stock or convertible debt, may have specific characteristics that affect cash flows. Adjust the present value of cash flows to account for these financing choices.
4. Sum the values: Add the unleveraged value of the project, the tax shield value, and any other financing-specific adjustments to obtain the adjusted present value.