Adjusted Present Value (APV) Approach Valuation

The Adjusted Present Value Approach 1 Firm Valuation: The Adjusted Present Value Approach  The adjusted present value (APV) approach is the one to firm valuation in which the entire firm is valued by adding the marginal impact of debt on value to the unlevered firm value.  In the process of looking at firm valuation, we also look at how leverage may or may not affect firm value. We note that in the presence of default risk, taxes, and agency costs, increasing leverage can sometimes increase firm value and sometimes decrease it. In fact, we argue that the optimal financing mix for a firm is the one that maximizes firm value.

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Adjusted Present Value (APV) Approach

Valuation: 중앙대학교 경영학부 박창헌 교수

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The Adjusted Present Value Approach

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Firm Valuation: The Adjusted Present Value Approach

 The adjusted present value (APV) approach is the one to firm

valuation in which the entire firm is valued by adding the

marginal impact of debt on value to the unlevered firm value

 In the process of looking at firm valuation, we also look at how

leverage may or may not affect firm value We note that in the

presence of default risk, taxes, and agency costs, increasing

leverage can sometimes increase firm value and sometimes

decrease it In fact, we argue that the optimal financing mix for a

firm is the one that maximizes firm value

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The Adjusted Present Value Approach

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The Value of the Unlevered Firm

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The Present Value of Tax Benefits

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The Present Value of Expected Bankruptcy Costs

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Credit Ratings by Agencies, Compared

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Credit Ratings Explained

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http:// www.interest.co.nz

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Example: Sovereign Debt Ratings

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http://blog.thomsonreuters.com/index.php/tag/credit-ratings/ Rating Agencies, c Dec 2014

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Estimating the Probability of Bankruptcy

empirical estimates of default probabilities for the rating

 For instance, Table 15.2, extracted from a study by Altman, summarizes the probability of default over 10 years by bond rating class in using the 1999 to 2008 time period 6

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(Supplement) Altman (1968)’s Original Z-Score

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Estimating the Probability of Bankruptcy

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※ The direct costs are the legal and liquidation costs of dissolving or reorganizing a

business, such as costs to hire accountants, lawyers, investment bankers

*See next slides for Warner’s study

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(Supplement) Bankruptcy Costs

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Findings from Jerold B Warner (1977) "Bankruptcy Costs:

Some Evidence," The Journal of Finance, 32 (May 1977)

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Source: Warner (1977)

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※The World Bank's Doing Business Report (2008) finds that in the United

States, the direct cost is approximately 7% of the assets of the firm - Lee et al

(2010)

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Example: Value of a Leveraged Deal

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APV without Bankruptcy Costs

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Cost of Capital [FCFF] vs APV Approach

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Cost of Capital [FCFF] vs APV Approach

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The Effect of Leverage on Firm Value

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The Effect of Leverage on Firm Value

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WACC, Firm Value, and Leverage

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Steps in Cost of Capital Approach

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Analyzing the Capital Structure (Disney Example)

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Analyzing the Capital Structure (Disney

Example)

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Example)

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Example)

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Example)

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Example)

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Default Risk, OI, and Optimal Leverage

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Adjusted Present Value and Financial Leverage

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APV Approach to Optimal Capital Structure

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Piecewise Valuation

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Benefits and Limitations of the APV Approach

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