Read more on the APV approach
In the APV approach, the value of
the firm is estimated keeping dollar debt fixed over time.
The tax benefits are computed on this dollar debt and the expected
bankruptcy cost is also based upon this dollar debt. In the
cost of capital approach, the debt ratio of a firm is kept
fixed over time. For firms that are growing over time, the
cost of capital approach will tend to yield the higher estimate
of value because it incorporates, into the current estimate
of value, your estimates of tax benefits from future debt issues.
In practice, analysts who use APV
add the expected tax benefits from debt to the unlevered firm
value and all too often ignore expected bankruptcy costs (which
are difficult to estimate). This valuation is incomplete since
it counts in the benefits of debt but does not consider the