Using APV: A better too for valuing operations

Since long business schools and text books used to teach WACC approach for
valuing operations but because its out there not because it performs the
best. Another alternative methodology that will soon replace WACC is APV
(Adjusted Present Value.)
Why choose APV over WACC?
APV always works when WACC does and sometimes when WACC does not
because it requires fewer restrictive assumptions. APV is less exposed to
serious errors than WACC. The major difference lies in added managerially
relevant information it can provide which is highly needed by todays
managers according to their needs. APV help manager analyze not only how
much an asset is worth but also it tells where the value comes from. APVs
approach is to analyze financial side effects separately and then add their
value to that of business. Whereas WACC addresses tax effects only-and not
very convincingly, except for simple capital structures. APV is nowadays
inexpensive, informative and flexible. A skilled analyst can customize a
valuation in whatever way makes most sense for the people involved in
managing its separate parts. APVs most significant characteristic is that it
uses no discount rate that contains anything other than time value and risk
premium.
An APV case study:
IBEX industries wants to acquire Acme Filters, a division of SL Corporation
that has underperformed in industry for last six years despite the measures
taken by management. The sellers have indicated that they wont accept
less than book value, currently $307M. Henry, owner of IBEX, believes that
deal can be financed with 80% debt. Henry wants to pay down debt as
quickly as possible and to arrive at a debt-to-capital ratio of no more than
50%. Acmes cost of equity is estimated to be 13.5%.
Executing an APV analysis:
1. Evaluate business as if it were financed entirely with equity.
2. Lay out the base-case cash flows ( Prepare performance forecasts i-e
Balance sheet income statement)
3. Discount the cash flows using an appropriate discount rate and
terminal value ( Discount the cash flows found in step one and terminal
values)
4. Evaluate the financing side effects ( e.g. Tax)
5. Add the pieces together to get initial APV (Add the results of 2 nd and 3rd
steps)

6. Tailor the analysis to fit managers needs (Separately analyze each

component)
The pitfalls of using WACC
In WACC based analysis we discount only once. When the capital structure
changes we miscalculate WACC. We use book values to generate weights for
WACC
Every element of WACC presents a computational challenge.