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APV approach begins with the value of the firm without debt. While debt is added
to the firm, the net effect on the value of the firm is examined by considering
both the benefits and the costs of borrowing. In these case, the assumption is
that the primary benefit of borrowing funds is the tax benefit, and the most
significant cost of borrowing is the additional risk of bankruptcy. Thus, in the
adjusted present value approach, the value of the firm is written as the sum of
the value of the firm without debt (the unlevered firm) and the effect of debt on
firm value.
Firm Value= unlevered firm value + (Tax benefit of debt Expected bankruptcy
cost from the debt)
Mechanics of APV valuation
To estimate the value of the firm, the steps are as follows:
(i)
(ii)
(iii)
100.00%
80.00%
CC
65.00%
CCC
46.61%
B-
32.50%
26.36%
B+
19.28%
BB
12.20%
BBB
2.30%
A-
1.41%
0.53%
A+
0.40%
AA
0.28%
AAA
0.01%