Adjusted present value

Adjusted present value
Primary topic
Related topics
Methods and techniques

Adjusted present value - the net present value of the investment project, calculated from the conditions of financing only from equity deposits and adjusted for the value of the present value of additional effects arising from the use of other forms of financing (Ootjers S. 2007, p. 9).

This method has been firstly suggested in 1974 by professor of MIT – Stewart Clay Mayers (Rappaport A. 1994, p. 190). The idea behind the adjusted present value method expresses the principle of "divide and conquer." This method does not cover all side effects in one calculation, but they can be aaded into one formula. First, the base cost of the project is calculated, i.e. the cost of the project is being calculated separately, as an institution, that provides funding only through the issuance of shares. Then, the present value of the costs or benefits that are incurred by the firm is calculated. Finally, all of the present values are added up and the total contribution of the project to the change in the value of the company is estimated.

APV method is a part of Discounted Cash Flow model (which represents a forecast of expected cash flows (and their growth rates), with an assessment of the risks of obtaining these flows both at the company (enterprise) level and at the level of an individual shareholder.) There are 3 methods of discounted cash flow assesment (Damodaran A. 2002, p. 12):

  • Equity Valuation – this method allows us to estimate the equity of the company.
  • Firm Valuation – this method helps to evaluate the company as one, which involves the need to take into evaluation other holders of claims in the company (like bondholders, preferred shares, etc.) in addition to equity.
  • Adjusted present value – devides company into parts. The evaluation process starts from the basic operations and then the impact on the value of debts and other claims not related to stocks is added.

Although in all three methods the expected cash flows are discounted, corresponding amounts of cash flows and the discount rates used vary depending on the method chosen.

Calculation[edit]

The concept of Adjusted Present Value (APV) implies an adjustment of the current value of a project (or company) and the value of the additional financial investemnts related to project (or company) (Horne J., Wachowicz J. 2008, p.408)\[APV=NPV+PV\space(side\space effects)\] Where: NPV - current value of the investment project or company; PV (side effects) - current cost of side investments related to project (company).

Thus, the algorithm for calculating the APV involves (BPP Learning Media 2017, p. 89):

  • evaluation of an investment project (or company) financed only by own funds;
  • identification of side effects associated with the financing of the project (or company);
  • calculation of the present value of the costs or benefits that will bring additional (side) effects;
  • summation of the baseline NPV side effects.

So more officially calculation of Adjusted Present Value is (Horne J., Wachowicz J. 2008, p.408)\[APV = \begin{bmatrix} \sum_{t=1}^n \frac{CF_t}{(1+k_e)^t} - ICO \end{bmatrix} + \begin{bmatrix} \sum_{t=1}^n \frac{(I_t)(T_c)}{(1+k_d)^t} - F \end{bmatrix}\] Where: CFt - is a business/project running cash flow, with already deducted tax in a certain time t; ICO - is the essential cash outplay of the project; ke (or keu) - is the necessary rate of recovery in case of lack of financial advantage; It - is the share payment quota of debt, which should be arranged on time t; Tc - represents corporate tax quota; kd - financing charges of debt financing, calculated before tax; F - back-up support cost, after tax calculations.

References[edit]

Author: Veronika Tomilova

.