The DCF approach to valuation and the multiples method of valuation are common. Where does the APV method come in? What are the advantages of the adjusted present value (APV) method of valuation?
The primary benefit of the APV method is that it separates the value derived from operations from the value derived from other sources such as interest tax shields, other tax shields, ancillary revenues/cash flows.
Valuing a firm with a single WACC assumes that the debt-to-equity ratio stays the same throughout the cash flow period. This is not realistic as firms repay debt or take on more debt. The APV method allows you to capture the changes in the debt ratios and the associated changes in tax shield benefits of each year individually.
The APV method first assumes that the firm is all-equity financed and values the firm’s operating cash flows with the cost of equity. To this value, it adds the present value of additional cash flows such as the tax shield and other streams of cash flows.