Formula
APV = NPV of FCFs at Unlevered Cost of Equity + PV of Tax Shields − PV of Distress Costs
Compare
| When to Use | WACC | APV |
|---|---|---|
| Stable leverage | Preferred — simpler | Works but unnecessary |
| Changing leverage | Inaccurate — WACC changes each year | Preferred — handles changing debt explicitly |
| LBO/restructuring | Misleading | Essential — debt changes dramatically |
| Tax shields at risk | Assumes full utilization | Can model uncertain tax shields separately |
Key point
APV is intellectually cleaner than WACC because it doesn’t mix operating value with financing effects. When a company’s leverage is changing (LBOs, restructurings, high-growth companies), WACC gives wrong answers because it assumes constant capital structure.
Try it
For an LBO target, try both approaches: WACC assumes constant leverage (wrong for LBOs) vs. APV models declining debt separately. The APV approach naturally handles the changing capital structure.
Check-in
A company plans to pay down $500M in debt over 5 years. Should you use WACC or APV?
Key insight
Check-in
You're DCF-ing a company with rapidly-changing capital structure (post-LBO, paying down debt fast). Is standard WACC approach still appropriate?
Check your understanding
Sit with the ideas.
A company generates $80M annual FCFF (perpetuity). Unlevered cost of equity is 12%. It has $500M of permanent debt at 6% interest. Tax rate is 25%. Using APV, what is the firm value?
Why: