Valuing German Companies Using the Adjusted Present Value Approach
Posted: 5 Sep 1997
Date Written: April 1997
Abstract
The purpose of the paper is to explain and to apply the Adjusted Present Value (APV)-approach, first mentioned by Myers (1974) to the valuation of German companies. We argue that this approach is to be preferred to the entity-method, if the relevant taxation system is not simply structured and if the probability that the necessary and restrictive conditions for applying the entity-approach are not given, is high. We show, that the flexibility inherent in the APV-approach is highly appropriate to value firms with changing capital structures over time, changing dividend policy, changing pension liabilities etc. Based on the work of Modigliani and Miller (1958, 1969) we present a valuation model under a specific set of assumptions, such as arbitrage-free capital markets, negligible risk of bankruptcy, similar borrowing conditions for private investors and corporations, and given investment decisions.The power and flexibility of the APV-approach is demonstrated against the background of the rather complex German imputation tax system. The APV-method does not require the restrictive assumptions of the widely used entity-approach (WACC-version). It does not encounter difficulties in dealing with fluctuating capital structures, peculiarities such as pension provisions and various pay out policies.This paper is organized as follows: Part II outlines the APV-approach and the German taxation system. Part III presents the basic valuation model under the assumption that all investors are (a) domestic and (b) holding fully diversified portfolios. Further details how to modify the valuation model in order to incorporate the perspective of foreign investors and non-diversified investors will be presented in Part IV. The valuation technique is illustrated by a realistic example.
JEL Classification: G12, G14
Suggested Citation: Suggested Citation