In what scenario is Adjusted Present Value (APV) preferred over net present value (NPV)?

Adjusted Present Value (APV) is preferred over net present value (NPV) particularly in scenarios involving major changes in gearing levels, which refers to the proportion of debt to equity in the capital structure of a company. The APV approach separates the value of an investment into two components: the value of the project if it were all-equity financed and the present value of the financing effects, such as tax shields from debt.

When a company experiences significant shifts in its capital structure—such as increasing or decreasing the amount of debt—APV provides a clearer picture of the project's value. This is because APV effectively allows for the pricing of financing decisions separately from operational cash flows. In contrast, NPV does not clearly break down these effects, potentially leading to misconceptions about the risks and benefits associated with the project's financing.

In cases where capital costs are stable or operating cash flows are constant, NPV can effectively capture the overall value of an investment as there are fewer complexities related to financing changes. Similarly, if financing is irrelevant, such as in an all-equity firm, NPV suffices since it doesn’t require the nuanced analysis that APV offers. Therefore, the preference for APV arises primarily in scenarios where refinancing or changes in capital