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When we calculate APV specifically the financing impact why do we have to calculate the interest saving and the tax benefit lost when we are financing with a cheap/subsidised loan??
Please help, thanks 🙂
In NPV discount factor is adjusted for all adjustments..
but APV was introduced to see how much equity and debt effects are there!!!
this is the main point which differs APV from NPV..
coming to your question..
we calculate interest saved because cheap loan, and due to cheap loan we lose tax savings on interest savings.. here come old concept of Opportunity Cost!!
Investment Appraisal is decision making tool, that why we see how much net savings come due to cheap loan!- Topics: 0
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an APV calculation can be split into two parts.
STEP 1
Firstly appraise the project as if being undertaken by an all equity financed company (this effectively ignores aspects of financing )
STEP 2
incorporate all the affects of financing.Coming to your query regarding the cheap loan. When an entity is provided with a cheap loan it has two effects upon APV .
1: interest cost is saved ( because the loan has been acquired at a rate cheaper than commercial loan )
2: tax saving are lost ( to understand this lets go back to good old financial accounting… interest costs are deducted in the I.S to arrive at the PBT figure. the more the interest cost the less would be the profits leading to reduced taxation. As we have cheap loan less interest cost would be deducted ( as compared to commercial loan ) leading to more profits and thus more taxation..
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