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Hi, All.
A very general question regarding NPV and APV.
In a lot practice question (For example, CIMA apptitude 2 appraisal investment Q10), I find APV yields different result from using NPV when evaluating project. One CIMA article says the difference is because APV does not factor in the increased debt capacity while WACC does.
If this is so, how can APV be generally considered preferable to NPV. It seems to me that Although APV can deal with changed capital structure more flexibly, it is hard to value increased debt capacity using APV.
I know in some questions, increased debt capacity is given. However, it is not given. How can we derive the same result as NPV?
There is the base case NPV which is calculated assuming all finance is by equity.
The APV is the base case + the value of the finance side effects.
They will, ingeneral be different unless pure equity is used for the finance.
NPV using cost of equity doe not capture the benefits that might arise from debt finance made artificially cheap by tax relief (which amounts to the government contributing the tax relief element) or subsidising the debt finance.
If you are not given the increase in debt capacity you can’t do anything as you have no data to work with.
Not sure if that answers your question. Come back if you need to.
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