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ACCA Strategic Professional · Advanced Financial Management · Impact of financing on investment decisions and adjusted present values

Under the adjusted present value (APV) approach, how should a project's financing side effects be treated relative to the base case NPV?

APV discounts the project's operating cash flows at the ungeared cost of equity to get a base case NPV, then values financing side effects such as tax shields and issue costs separately and adds them. The discount rate is not adjusted for financing.

  1. AIncluded by adjusting the discount rate used in the base case
  2. BValued separately and added to the base case NPV, which is discounted at the ungeared cost of equityCorrect
  3. CIgnored because the Modigliani and Miller no-tax model shows financing is irrelevant
  4. DDeducted from the initial investment and then discounted at the WACC

Explanation

APV first calculates the base case NPV as if all-equity financed, using the ungeared cost of equity. Financing side effects such as the tax shield on debt interest and issue costs are then valued separately and added. Adjusting the discount rate is the WACC method, not APV.

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