Adjusted Present Value (APV)

Approach

Valuation: 중앙대학교 경영학부 박창헌 교수

The Adjusted Present Value Approach

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.

1

The Adjusted Present Value Approach

2

The Value of the Unlevered Firm

3

The Present Value of Tax Benefits

4

The Present Value of Expected Bankruptcy Costs

5

Credit Ratings by Agencies, Compared

6

Credit Ratings Explained

http:// www.interest.co.nz

7

Example: Sovereign Debt Ratings

Rating Agencies, c. Dec. 2014

http://blog.thomsonreuters.com/index.php/tag/credit-ratings/

8

Estimating the Probability of Bankruptcy

There are two basic ways in

which the probability of

bankruptcy can be estimated

indirectly. One is to estimate a

bond rating and use the

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

9

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

10

Estimating the Probability of Bankruptcy

*See next slides for Warner’s study.

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

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

11

(Supplement) Bankruptcy Costs

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

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

12

(Supplement) Bankruptcy Costs

Source: Warner (1977)

13

(Supplement) Bankruptcy Costs

Source: Warner (1977)

14

(Supplement) Bankruptcy Costs

※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)

Source: Warner (1977)

15

Example: Value of a Leveraged Deal

16

Example: Value of a Leveraged Deal

17

Example: Value of a Leveraged Deal

18

Example: Value of a Leveraged Deal

19

APV without Bankruptcy Costs

20

Cost of Capital [FCFF] vs. APV Approach

21

Cost of Capital [FCFF] vs. APV Approach

22

The Effect of Leverage on Firm Value

23

The Effect of Leverage on Firm Value

24

Approach

Valuation: 중앙대학교 경영학부 박창헌 교수

The Adjusted Present Value Approach

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.

1

The Adjusted Present Value Approach

2

The Value of the Unlevered Firm

3

The Present Value of Tax Benefits

4

The Present Value of Expected Bankruptcy Costs

5

Credit Ratings by Agencies, Compared

6

Credit Ratings Explained

http:// www.interest.co.nz

7

Example: Sovereign Debt Ratings

Rating Agencies, c. Dec. 2014

http://blog.thomsonreuters.com/index.php/tag/credit-ratings/

8

Estimating the Probability of Bankruptcy

There are two basic ways in

which the probability of

bankruptcy can be estimated

indirectly. One is to estimate a

bond rating and use the

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

9

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

10

Estimating the Probability of Bankruptcy

*See next slides for Warner’s study.

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

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

11

(Supplement) Bankruptcy Costs

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

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

12

(Supplement) Bankruptcy Costs

Source: Warner (1977)

13

(Supplement) Bankruptcy Costs

Source: Warner (1977)

14

(Supplement) Bankruptcy Costs

※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)

Source: Warner (1977)

15

Example: Value of a Leveraged Deal

16

Example: Value of a Leveraged Deal

17

Example: Value of a Leveraged Deal

18

Example: Value of a Leveraged Deal

19

APV without Bankruptcy Costs

20

Cost of Capital [FCFF] vs. APV Approach

21

Cost of Capital [FCFF] vs. APV Approach

22

The Effect of Leverage on Firm Value

23

The Effect of Leverage on Firm Value

24

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