The simulation results are presented in a collection of tables and figures that contain the average value from 5,000 trials, for varying levels of project risk, for two measures of project value: 1) the value of the project to the entire firm (the adjusted present value) and 2) the value of the project to the shareholders (the NPV).
The results indicate that the adjusted present value of the project increases as project risk rises.
The average adjusted present value of the riskless project in Panel B is $751.30 compared to $753.62 in Panel A.
Adjusted present value (APV) is known as a "divide and conquer" approach.
For the valuation of the step-up induced tax benefits, two alternative approaches are meaningful: a standalone valuation, which only calculates the net present value of the tax shield by applying a discount rate which includes the tax benefit of debt with respect to the financing mix, or a valuation via an additional term in the framework of the Adjusted Present Value method (Myers (1974), where the debt tax benefit is already accounted for in the second term of the APV-Formula.
The Adjusted Present Value method has been gaining importance in the recent past, not only among theorists, but also for practitioners.
This step of the adjusted present value approach poses the most significant estimation problem, since neither the probability of bankruptcy nor the bankruptcy cost can be estimated directly.
To understand when the cost of capital approach, the adjusted present value approach and the modified adjusted present value approach (with capital cash flows) yield similar and different results, we consider the mechanics of each approach in Table 2.1.
The
adjusted present value resulting from the asset view of the balance sheet (Fig.
Choosing Between Capital Cash Flows and
Adjusted Present Value Methods
To implement the adjusted present value method, the debt schedule in Exhibit 5 can be used to calculate the schedule of effective debt tax shields, [r.sub.fe] [G.sub.L] [D.sub.n-1], as shown in Column j6, However, these must be discounted iteratively, using Equation (3B.1), since only the next period's cash flow is certain at any given time.
(iii) Although consistent valuation is possible using any of the three methods when the firm maintains a constant leverage ratio, the adjusted present value and flows to equity methods are cumbersome, and the adjusted discount rate method is preferred.
