A problem with the Discounted Cash Flow (DCF) is that this method does not take into account a changing financing structure. The DCF method calculates current value based on future cash flow based on a non-changing average cost of capital. In practice, however, the capital structure of most SME companies is variable. Loans are terminated and redeemed, and the lending of SMEs fluctuates relatively strongly when compared to larger companies. This changes the equity / debt ratio and thus the average cost of capital.
The Adjusted Present Value (APV) can be seen as a variation of the Discounted Cash Flow, with the addition that the APV takes into account the fluctuating ratios between debt and equity.
The calculation of the value of an online business, according to the APV, consists of two parts. As with the DCF, the value of the operational activities is calculated. Then (and here's the difference with the DCF), the value of the tax benefit, linked to the financing with interest-bearing debt, is calculated. This is the so-called 'taxshield'.
In case of the valuation of an activity, the Adjusted Present Value assumes 100% equity financing (no debt). The cash flow is obtained in the same manner as in the DCF method and subsequently discounted at the cost of unlevered equity. The valuation of the tax shield consists mainly of the tax benefit on interest payments. Interest is tax deductible and the deductibility of the interest increases the value of the company.
Depending on the risk profile of an online business, a discount rate for the tax shelter is determined. It's usually in between the cost of debt and the cost of 100% equity.
The use of the APV provides better insight into the value of the company. In addition, the APV makes clear the effects of tax benefits on co-financing with debt. In other words, the effects of a changing financing structure are covered.
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