APV vs. DCF
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The discounted Cash Flow (DCF) model is broadly used as a method to estimate the value of target companies in the M&A deals. The method uses the weighted average cost of capital (WACC), including both equity and debt cost of capital, to discount the cash flows. However, in private equity, where the debt level is dramatically changing, this method becomes problematic. Therefore, private equity firms use the Adjusted Present Value approach (APV) instead.
The two methods are very similar. However, in APV, the enterprise value is composed of two components. First component is the present value of all future cash flows (including exit/terminal value of the investment) discounted at the equity cost of capital. The second component is the present value of all tax savings/tax shield discounted at the cost of debt.
Have studied valuation from both academia and investment banking perspectives. Interestingly, in academia, only DCF is considered a true evaluating technic. In investment banking comparables, precedent transactions are important the same as DCF. There is a joke in investment banking:
What is the value of the target in DCF analysis?
Any what you want them to be!
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