Apv

[ssab]

in calculatring APV why don t we take interest as cost in financial side effects as an expense where as we take tax sheild on same interest cost as cash inflow. plese help me

[Pavan S]

APV = Base case NPV + PV (tax benefits) – PV (issue costs and bankruptcy costs)

The interest cost is already taken into account while calculating the base case NPV and so only the tax shield is considered.

Hope this helps.

kevin

[registoni]

in calculatring APV why don t we take interest as cost in financial side effects as an expense where as we take tax sheild on same interest cost as cash inflow. plese help me

i would just add that in DCF models the interest expense is not included in the calculatons at all, because it is accounted for when applying the discount rate. The discount rate is the cost of capital of the firm and integrates compensation for time value of money and specific project risk (the same way as the interest on debt). Including the interest payment as cash outflows in any DCF calculations would mean double-counting, punishing the firm twice for leverage (increasing debt) which is incorrect, of course.
As for AVP, the first part of it consist in calculating the NPV of the project as it was all-equity financed, ignoring debt. This will involve the calculation of asset betas from equity beta (unlevering/ungearing) and use this beta in CAPM formula to get the discount rate, which is used to calculate NPV of the project. The Cash flows in this part of APV should exclude any debt/financing related ones (such as interest payments, tax shield, etc)
The second part of APV is calculation of PV of the tax shield (tax benefit on the fact that interest on debt is tax deductable) = Annual Interest * Tax Rate/(1+kd)¬n. This tax shield is discounted by the cost of debt (kd).
The third part of APV is PV of financial distress, which is Probability of Bankruptcy * Costs of Bankruptcy. This is often ignored in calculations, as it is very difficult to estimate (they might say "we don't expect the bond rating of the company will change" - meaning the default risk is not gonna affect it).
APV = NPV all equity + PV of tax shield + PV of fin.distress