The concept of APV (Adjusted Present Value) is based on :
- Calculating Base Case NPV (Assuming all Equity Financing)
- Adding PV of Interest Tax Shield discounted using Pre-tax Kd
Base Case NPV is calculated by Discounting Cash Flows using Unlevered Ke (which is calculated using unlevered Beta).
Sir mentioned in class that we can also directly compute the NPV (instead of APV) by calculating Levered Ke (using levered Beta) and then computing Kc using the weighted average of Post Tax Kd and Levered Ke. The Cash Flows are then discounted using Kc to arrive at NPV.
In the Question dictated by Sir in New Types of Sum – 7 (https://www.youtube.com/watchv=B7_gqRhlMGs&list=PLP3KuMma5JaqCwyPksNjQSqOAjRQsbmck&index=10), the answer via APV Method is -2.74 Cr.
However, if we compute NPV by discounting the same Cash Flows (Year 1 – 140 Cr, Year 2 – 180 Cr, Year 3 – 220 Cr, Year 4 – 330 Cr) using Kc (Kc comes out to 19% , Levered Beta is 6, Levered Ke is 36% and Post Tax Kd is 10.5%, Debt is 400 Cr and Equity is 200 Cr, Unlevered Beta is 2.5, tax rate is 30%), then the answer comes to -60.13 Cr.
Why are the answers of APV and NPV NOT Equal ?
And In case both APV and NPV always give different answers, which is the better method conceptually and technically (APV or NPV) for evaluating the viability of a project ?
Also, Will we use the SAME Cash Flows (CFAT) for both APV Method (discounted using Unlevered Ke) and NPV Method (discounted using Kc) ? (please tell me if the below written logic is correct?)
Due to the Assumption of all Equity Financing in Base Case NPV (in APV Method), Cash Flows for Equity and Cash Flows for the Firm should be same. We should ideally use Cash Flows for Equity as we are using Unlevered Ke as the discount rate. But due to the absence of Debt, Unlevered Ke = Kc and Cash Flows for both Equity and Firm are same.
In NPV Method, since we are using Kc as discount rate, so we should use Cash Flows For Firm i.e. NOPAT + Depreciation.
Hence, for calculating both Base case NPV (in APV using Unlevered Ke as discount rate) and NPV (using Kc as discount rate), exactly same Cash Flows should be used, just the discounting rate would be different for APV (Base Case NPV) and NPV
APV and NPV wont be same. And as you asked which is better, it depends upon situation to situation like analysing for the firm or you want to analyse for equity. No we use different cash flows for both for APV we use FCFE and for NPV we can use CFAT.
In APV, we use FCFE, but due to the assumption of all Equity Financing in APV (Base Case NPV), FCFE would be equal to FCFF (and CFAT). We know that FCFF (i.e. CFAT) is used for NPV. So, effectively, we can use the same Cash Flows in a question to calculate both APV and NPV ?
For Example, in the question given by Sir (in the above mentioned Youtube Video), if I want to calculate NPV (instead of APV) by calculating Levered Ke (using levered Beta) and then computing Kc using the weighted average of Post Tax Kd and Levered Ke.
Then, to calculate NPV, can I use the exact same cash flows (CFAT) used for APV (i.e 140 Cr in Year 1, 180 Cr in Year 2, 220 Cr in Year 3 and 330 Cr in Year 4) and discount them by Kc computed above using levered Ke and Post Tax kd ?
Infact, in the class Notes dictated by Sir (in the above mentioned Youtube Video), he had told us to use CFAT for APV Calculation, I guess due to the Assumption of all Equity Financing in APV, both CFAT and FCFE would be same ?
Also, FCFF and CFAT are one and the same thing only ?