Adjusted present value definition
/What is Adjusted Present Value?
Adjusted present value is the net present value of a proposed project as though it were to be solely financed with equity, and incorporating the present value of any effects associated with debt financing. This adjustment is intended to improve the present value of the project by incorporating any tax shield associated with the deductibility of interest payments for income tax purposes. Once the adjustment has been included, you should accept projects having a positive adjusted present value, and reject those with a negative adjusted present value.
Advantages of Adjusted Present Value
The key advantages of the adjusted present value concept are as follows:
Flexibility in handling financing effects. Adjusted present value explicitly separates the value of a project as if it were financed entirely with equity (the unlevered value) from the value created by financing decisions (e.g., tax shields, subsidies, and costs of financial distress). This separation makes it easier to analyze and adjust for the effects of different financing structures.
Clearer insight into value drivers. By isolating the operating value and financing effects, adjusted present value provides better insight into what drives the value of a project, allowing for a more detailed analysis and understanding.
Handles complex capital structures. The adjusted present value method can handle scenarios with non-constant debt levels, varying interest rates, or unique financing arrangements more effectively than the Weighted Average Cost of Capital approach.
Highlights the impact of tax shields. The adjusted present value concept explicitly quantifies the tax shield benefits of debt, making it easier to assess the impact of interest deductions on project value.
Adaptability to changing debt levels. This method can adapt to situations where debt levels change over time, such as in a leveraged buyout (LBO).
Better for highly-leverage projects. For projects with significant debt financing, the adjusted present value method accurately reflects the incremental value from tax shields and other financing effects.
The adjusted present value concept provides a robust and flexible framework for valuing projects, especially in cases with complex financing structures or changing debt levels. Its ability to separate operating and financing effects ensures greater accuracy and transparency, making it a preferred method in financial modeling for real-world applications.