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Describe the steps required to apply the APV approach. |

Explanation

For applying the adjusted present value method, following steps must be followed:

Step 1- Identify post-merger annual free cash flows and annual tax savings.

Step 2- Calculate the unlevered cost of equity. This eliminates the effect of debt in the capital structure.

Step 3- Calculate the horizon value of unlevered cash flows. This is calculated using the constant growth formula with unlevered cost of equity as the discount rate.

Step 4- Calculate the horizon value of the tax shield. This is calculated using the constant growth formula with unlevered cost of equity as the discount rate.

Step 5- Calculate the unlevered value of operations as the present value of annual free cash flows and horizon

value of unlevered cash flows. The unlevered cost of equity is used as the discount rate.

Step 6- Calculate the value of the tax shield as the present value of annual tax savings and the horizon value of the tax shield. The unlevered cost of equity is used as the discount rate.

Step 7- Calculate the final value of operations as the sum of unlevered value of operations and the value of tax shield.

Verified Answer

Following steps must be taken into consideration to apply adjusted present value method:

Step 1- Identify post-merger annual free cash flows and annual tax savings.

Step 2- Calculate the unlevered cost of equity.

Step 3- Calculate the horizon value of unlevered cash flows.

Step 4- Calculate the horizon value of the tax shield.

Step 5- Calculate the unlevered value of operations. It is the sum of the present value of annual free cash flows and the horizon value of unlevered cash flows.

Step 6- Calculate the value of the tax shield as the present value of annual tax savings and the horizon value of the tax shield.

Step 7- Calculate the final value of operations as the sum of unlevered value of operations and the value of tax shield.

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