Adjusted present value
DCFValuing a business as if unlevered, then adding the value of financing effects separately, used when the capital structure changes over time.
Also written: APV
WACC assumes a constant capital structure, because the weights are fixed for the whole forecast. That assumption breaks in a leveraged buyout, where leverage starts high and falls every year as debt is repaid, so no single WACC is correct for any of the years.
APV separates the two questions. Value the unlevered business by discounting unlevered free cash flow at the unlevered cost of equity, which prices the operations alone. Then value the financing effects, principally the interest tax shield, period by period and add them.
The sum is the enterprise value, and the split is informative in itself: it tells you exactly how much of the value comes from the business and how much from the way it was funded, which a WACC based DCF buries.
The judgement call is what rate to discount the tax shield at. Discounting at the cost of debt treats the shield as being as safe as the debt itself; discounting at the unlevered cost of equity treats it as risky as the operations that must generate the profit for the deduction to be usable.
Worked example
Unlevered free cash flows discounted at a 10% unlevered cost of equity give an unlevered enterprise value of 800.
Debt starts at 600 and amortises. Interest at 6% generates a tax shield of 0.25 times the interest each year, and the present value of those shields over the hold is 55.
APV enterprise value is 855. The split is the useful part: 800 from the business and 55 from the financing, which a single WACC would have buried.