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The Adjusted Present Value (APV) approach can handle both perpetual and uneven cash flows. It can be used in calculating the adjusted present value of a levered firm that has many financing effects. The APV approach divides the NPV into two basic parts −The first part includes the all-equity NPV, assuming that the project is entirely financed by equity.The second part consists of the interest tax shields and all types of financing effects.We can write, $$\mathrm{APV = All\:Equity\:NPV\:+\:Value\:of\:Financing\:Effects}$$Steps in Adjusted Present Value ApproachThe use of APV consists of three steps −The first state of application of APV includes determination of ... Read More
A pure-equity or an unlevered firm obtains all its funds internally and does not require to obtain any debt from the market. In other words, pure-equity firms are debt-free. Therefore, in case of an investment, a pure-equity firm doesn’t have to pay any interest for the debt the company may acquire from the market.Debt-free companies may use retained earnings or revenues generated from their existing projects to fund an investment project, so they do not need to acquire financing externally.Pure-equity firms use the asset cost of capital instead of the cost of equity to fund their investment projects. It is ... Read More
Asset cost of capital refers to the capital of a firm when the financing of a project is purely done by equity without any form of debt. It is the expected rate of return on the company's assets in a hypothetical debt-free method. Asset cost of capital is also known as the unlevered cost of capital because it is done without any financial leverage of debt. It is completely a financial position where a company can finance without taking care of any debt.The cost of executing a project in a completely debt-free manner is the asset cost of capital. As ... Read More
Like Free Cash Flow (FCF) and Capital Cash Flow (CCF), Adjusted Present value (APV) is another way of evaluating an investment project. However, it is completely different from FCF and CCF approaches.FCF and CCF are primarily related to interest tax shields and they do not consider the various financing effects that may affect the value of the investment project. In fact, most of the investment projects contain some form of financing effects and so Adjusted Present Value approach is a more utilized approach in practice.It is known that FCF approach of evaluating a project is good when the debt-to-value ratio ... Read More
What are Issue Costs?When companies raise money from the market, it needs to distribute securities in the market which requires the company to incur some cost. These one-time costs are called issue costs that have to be considered while the project begins. It is a preliminary cost all companies must spend to raise money from the investors in the market.How to Handle Issue Costs?Issue costs are handled at the outset of a project. The best way to manage the issue cost is to use the APV model to evaluate an investment project. In APV approach, the issue cost is discounted ... Read More
The levered cost of equity represents the risk components of the financial structure of a firm. To finance the projects of a firm, companies often need to resort to debt that is collected from the market. The market offers the debt by the resources of the investors.In case of levered cost of equity, the firms have larger debt proportions, and hence the firms must convince the investors that it is capable to provide the business and financial risk premiums.In general, when a company uses unlevered cost of equity, it does not go for debts from the market. It uses the ... Read More
A balance sheet is made up of assets and liabilities and hence the balance sheet approach of evaluating a firm shows the values of the assets of a company.Book Value of Assets is the Minimum Value of a FirmWhen the values are un-adjusted, the balance sheet approach indicates the claims of investors over the assets of the company. That is, the book value of equity funds and debt funds represent the value of the firm the investors have ownership on. Therefore, the minimum value of a firm is equal to the book value of assets.Value of a Firm is Worth ... Read More
The Free Cash Flow approach using WACC for the evaluation of investment projects has certain limitations −Cash Flow PatternsThe original WACC is based on an assumption that cash flow patterns are perpetual. In fact, there is no such behavior in case of cash flow patterns. However, WACC works in all types of cash flows.Business RisksWACC assumes that a project or a business has the same risks as the existing assets of the company. This may be true in case of a small expansion in assets but for completely different types of businesses, this may not be applicable.The evaluation of a ... Read More
The Adjusted Present Value of a project takes the Net Present Value (NPV) of a project and adds this with the cost of debt, including financing effects, such as interest tax shield, issue costs, costs of distress, and subsidies etc. The APV is used instead of NPV for evaluating an investment project for various reasons. Here's why APV is used more frequently than other methods of evaluation of a project.The Effect of Debt and EquityThe use of all-equity financing may be debilitating for the health of a company's financials. In some situations, the NPV of such project turn positive due ... Read More
Loan-to-Value RatioThe loan-to-value ratio (LTV) is a ratio of loan one wants to borrow to the appraisal value of property he or she can produce as a collateral.LTV is a measure of the capability of handling a loan and repay the interest and the principle in theoretical terms.Higher LTV value means more risk as the loan amount goes up but the repayment capability remains the same.LTV shows how much property a borrower of the loan actually owns to the real value of the property that was charged while the borrower bought the property.Lenders usually determine the risk associated with the ... Read More