In the process of investing money in any investment project
In the process of investing money in any investment project, the key point for the investor is to assess the economic feasibility of such an investment. An investor seeks the ways to not only recoup own investments, but also to earn something more than the amount of the initial investment. In addition, the task of the investor is to search for alternative investment options, which (under comparable risk levels and other investment conditions) would bring higher returns. Thus, the main aims of the assignment are to define APV, to find differences between APV (Adjusted Present Value) and NPV (Net Present Value), as well as to discuss the most popular instruments for valuing projects.
Defining APV, Sabal (2007) mentioned that this is the method of calculating the value of the net assets of the fund in the case of its financing solely from its own capital (the present value of cash flows excluding attracted capital), as well as the present value of any decisions to raise funds (cash flows including borrowed funds). In other words, according to Rich et al (2018), various forms of tax protection, possible due to the deduction of interest, as well as the benefits of other investment tax credits, are calculated separately. This method of calculation is often used for transactions with a large proportion of attracted capital, for example, the purchase of a controlling stake from a loan. This method has the advantage that can be easily applied to any new theoretically proven effects of the influence of financial policy on the cost of the project.
Observing the main differences between APV and NPV, it is good to note that it is possible to calculate the effect of an investment project in two ways. Firstly, NPV method can be used to evaluate a project. To do this, it is important to calculate the cash flow from the project assets and discount it, using the weighted average cost of capital as the discount rate. Secondly, it is possible to use the APV technique. To do this, there is a need to calculate NPV0 – the net present value of the base case of the project, i.e. under the option of financing entirely at the expense of equity. At the same time, according to Orsag et al (2013), it is required to calculate cash flows from the project assets and make them discounting according to the cost of equity. Then it is necessary to add to this value NPV0 “side effect” – the present value of the tax shield PV (TS). In practice, these methods often give significantly different results. This is conditioned by the fact that calculations are based on different assumptions often based on these methods.
Identifying and discussing other business valuation models that are popular, it is necessary to describe IRR (Internal Rate of Return) that is the discount rate at which NPV of the project is equal to zero. In other words, according to Liljeblom & Vaihekoski (2004), the present value of all expected cash flows of the project is equal to the value of the initial investment. The method of discounted cash flows is the basis of the IRR method, and the indicator itself has been widely used in the budgeting of capital investments and in making investment decisions as a criterion for selecting projects and investments.
In addition, DCF (discounting cash flow model) is also worthy of mention. Its essence lies in the simple determination of free cash flows, the identification of the terminal value of the project and the subsequent discounting of the results obtained according to the discount rate. Indeed, over the past years, the technique has proved its simplicity, cheapness and dependability of work. Economic substantiations of practically all business processes were made with its help: from the expansion of production and re-equipment to large mergers and acquisitions. Despite some shortcomings, according to Ruback (2002), no one tries to prove the inexpediency of this technique: its logic is accessible and understandable, and the calculation methods at the program level are perfected.
In conclusion, we have defined the essence of APV and the main issues associated with it, and have explained that the value of the APV method lies precisely in its flexibility; its ability for managerial analysis. The structure of the APV is transparent and easily divisible based on management requests. APV allows to “decompose” all the economic components of the project. The main advantage of the method is the ability to take into a consideration the company’s capital structure and economic drivers separately. As a result, the received information is more informative.