The Mismatching of Apv and the DCF in Brealey, Myers and Allen 8th Edition of Principles of Corporate Finance, 2006

Abstract

In the latest edition of Principles of Corporate Finance (Brealey, Myers and Allen, 2006) the authors use a finite cash flow example to illustrate the valuation procedure for using the Discounted Cash Flow (DCF) method with the free cash flow (FCF) and the Adjusted Present Value (APV). The two firm values obtained are different. They say that the "... difference [...] is not a big deal considering all the lurking risks and pitfalls in forecasting [...] cash flows".

In this teaching note we show that the two methods give identical values when the proper discount rates are used.

Keywords: Cash flows, free cash flow, cash flow to equity, valuation, levered value, Adjusted Present Value, APV, Discounted Cash Flow, DCF, weighted average cost of capital, WACC, cost of unlevered equity, tax savings

JEL Classification: M21, M40, M46, M41, G12, G31, J33