Page 227 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes T t
(1 i ) t = Present value of interest tax shields
+
d
S t = Present value of interest subsidies
(1 i ) t
+
d
The various symbols denote
T = Tax savings in year t due to the financial mix adopted
t
S = Before-tax value of interest subsidies (on the home currency) in year t due to project
t
specific financing
i = Before-tax cost of dollar debt (home currency)
d
The last two terms in the APV equation are discounted at the before-tax cost of dollar debt to
reflect the relative certain value of the cash flows due to tax savings and interest savings.
The benefit of APV is that it breaks the problem down into the value of the project itself, as if it
is totally equity financed and the value of the debt financing. This makes APV flexible enough
to cover many different types of real-world financing arrangements such as: changes in tax rates
every year, changes in amounts of debt every year, subsidy in interest payments for a certain
number of years, flotation costs, etc. In each of these cases the NPV of the project if it were 100%
equity financed would remain the same, and the value of the specific financing arrangement
would simply be calculated separately.
Thus, APV focuses on two main categories of cash flows:

1. Real CFs (revenues)
2. Side effects associated with its financing programme (such as value of interest tax shields,
subsidized financing)

APV = NPV of project assuming it is all equity financed + NPV of financing side effects
Essentially, APV breaks the total value of the project into two parts: one part is the value
assuming no debt is used, and then we add on the extra value created from using debt in the
capital structure. There are four side effects of financing i.e. using debt in the capital structure:
The Tax Subsidy to Debt

The Costs of Issuing New Securities
The Costs of Financial Distress
Subsidies to Debt Financing
There are two steps in calculating an APV for a project:
Step 1: Calculate NPV for unlevered project (NPV)

Step 2: Calculate NPV of financing side (NPVF)
Step 3: Add up.
APV = NPV + NPVF
The unique features of the APV technique are:

APV handles complexities with a lot of subsections.
The APV format allows different components of the project’s cash flow to be discounted
separately depending upon the degree of certainty attached with each cash flow.

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