How to Calculate Adjusted Present Value

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Adjusted present value (APV) is a financial measurement used to determine the worth of an investment. Specifically, it describes the potential profitability of a project by analyzing the present amount of cash inflows and comparing it to the present amount of cash outflows. Being able to calculate adjusted present value allows you to compare the value of competing businesses and ultimately make more informed investing decisions.

• Determine the project's base net present value. To do this, you will need to know the cost of equity, the life of the project, the initial cost of the project and the cash flow for at least one year of operation. Once you have this information, use an online net present value calculator to determine the base NPV. You must use the cost of equity in place of the discount rate when entering the information into the calculator.

• Determine the present value of the financing effect. To do this, you will need to know how much debt will be incurred for the project, the cost of the debt, the interest rate on the debt and the tax rate. Once you have this information, plug the data into the following formula to determine the present value of the financing effect.

F = (T x D x C) / I

F = Financing Effect
T = Tax Rate
D = Dent Incurred
C = Cost of Debt
I = Interest Rate of Debt

For example, if you had a project that was financed with \$100,000 of debt, with the cost of debt as 10 percent, at an interest rate of 10 percent, and all of this took place in an economic environment where the tax rate was 30 percent, you would have the following equation:

F= 30% x 100,000 x 10%) / 0.10.

F= (30,000 x 10%) / 0.10
F= (3,000) / 0.10
F= 30,000

• Add the present value of the financing effect to the base net present value. The sum of the two numbers is the adjusted present value. For example, if the project had a base net present value of -\$5,000 and a financing effect value of \$30,000, you would add them together to get an adjusted present value of \$25,000.

Tips & Warnings

• The main benefit of using an adjusted present value calculation, as opposed to a net present value calculation, is that it can help reduce tax liability by taking interest payments into consideration.

References

• Photo Credit Accounting and finances image by MAXFX from Fotolia.com
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