APV Approach to Equity Value

Now that we have a horizon value for Ideko that summarizes the value of the firm’s free cash flow beyond the forecast horizon, we can combine it with our forecast for free cash flow through 20Y0 to estimate Ideko’s value today.

Because the debt is paid on a fixed schedule during the forecast period, the APV method is the easiest valuation method to apply (if we chose the DCF WACC method, because the debt to equity ratio changes each year, we would have to re-compute the WACC each year too).

Unlevered Value

The steps to estimate Ideko’s value using the APV method are shown in the spreadsheet

  • First, we compute Ideko’s unlevered value \(V^U\), which is the firm’s value if we were to operate the company without leverage during the forecast period and sell it for its horizon value at the end of the forecast horizon.
    • Thus, the final value in 20Y0 would be the continuation value we estimated earlier.
    • The value in earlier periods includes the free cash flows paid by the firm (Ideko - Forecast FCFs), discounted at the unlevered cost of capital \(r_U\) that we estimated here (Ideko - Unlevered Cost of Capital)
\[V^U_{t-1} = {FCF_t + V^U_t \over {1 + r_U}}\]

Tax Shield

Next, we incorporate Ideko’s interest tax shield during the forecast horizon. The interest tax shield equals the tax rate of 35% multiplied by Ideko’s scheduled interest payments (Ideko - Capital Structure).

Because the debt levels are predetermined, we compute the value \(T^s\) of the tax shield by discounting the tax savings at the debt interest rate, \(r_D = 6.80 \text{ %}\):

\[\begin{align*} T^s_{t-1} = {\text{Interest Tax Shield}_t + T^s_t \over {1 + r_D}} \end{align*}\]

Equity Value Estimate

Combining the unlevered value and the tax shield value gives the APV, which is Ideko’s enterprise value given the planned leverage policy. By deducting debt, we obtain our estimate for the value of Ideko’s equity during the forecast period. The APV calculations are shown below:


Thus, our estimate for Ideko’s initial enterprise value is $213 million (see above), with an equity value of $113 million. As Kleiner Perkins’ initial cost to acquire Ideko’s equity is $53 milion (Ideko - Acquisition Financing), based on these estimates the deal looks attractive, with an NPV of $113 million - $53 million = $60 million.