The adjusted present value (APV) is the net present value (NPV) plus the present value (PV) of any financing benefits or additional effects of debt. For example, the benefit of debt would include the tax deductibility of the interest paid on the debt. Present value is calculated by adjusting or discounting a future or projected amount to take into consideration the decrease in value over time.
Adjusted present value method is a technique for determining the worth of a potential investment. It is assumed that the project is funded by equity of the business. The value of assets is determined prior to the project, then both the benefits and costs of borrowing money is calculated. A business can then compare different types of funding for a project by comparing the adjusted present value.
In order to determine the adjusted present value of an investment or project, a person must first calculate the project’s net present value. Information necessary includes the cost of equity, how long the project will last, the initial cost of the project, and the cash flow for the first year of the operation. An online net present value calculator could be of help with the calculation.
The present value of the benefits and costs of borrowing is then added to the net present value. A formula to determine the present value of the financing effect would be F=(T x D x C)/I, where F is financing effect, T is the tax rate, D is the debt incurred, C is the cost of debt, and I is the interest rate of debt. The final step is to add the present value of the financing effect to the base net present value; the sum of the two numbers is the adjusted present value. This value is used in determining which projects or investments would be of most value to a business.
A disadvantage of financing a project with debt rather than with equity is that it includes more risk to the business. Using debt financing, however, has the advantage of maintaining control of the business interest. An added benefit to using debt financing is the tax implication — interest that is paid on loans is deductible.
Companies may choose equity to finance projects to provide additional funds. Obtaining additional equity funds by acquiring additional investors, however, could dilute the control of the business. In addition, amounts that are paid to stockholders in the form of dividends are not deductible for the business. Whether a company should use equity financing or debt financing will depend on such things as potential investors, available capital, tax rates, types and number of projects being considered, and current debt of the company.
