The pattern of Q1 in ACCA AFM is to open up with a part (a) testing a theory part of the syllabus. In this blog, I want to cover one of the most popular topics – NPV vs APV. Or should this read NPV & APV ?
AIA with or without real options has to be tested in the ACCA AFM exam to some extent. This covers big range of potential areas. Also, it does not necessarily have to be calculation based. Hence the reason for this blog.
A project’s NPV represents the change in shareholder wealth. The increase (or decrease) in the Ve. When computing its value the risks associated with the project has to be matched with the discount rate.
If the project is a repeat of past business activities (core) and the project finance will not change the company’s capital structure, the company WACC should be used.
However, holding the latter constant and changing the former to a non core project, the risk adjusted WACC will apply.
In both cases the project’s future free cash flows (FCF) are discounted at one of the ‘WACC’s’.
APV can apply irrespective of whether the project is a core or non core project. A point students fail to mention. The project’s Kei accrues for this. The same FCF’s mentioned above are discounted at Kei to find the base case NPV.
This is only half the story. APV comes into play when the project has unique finance and this leans on debt. Debt has the advantage of the tax shield on the interest paid and may have a subsidised interest rate.
The NPV of the finance cash flows are ascertained separately using a debt related discount rate.
Hence the APV is the combination of two NPV’s – base case + finance cash flows.
Most important of all is that APV is just another NPV. It still represents the change in the Ve.
So project appraisal using Co WACC, RAWACC or the APV approach are all members of the same family. They show the change in shareholder wealth.