NISM Series XIX-A · Chapter 11: Valuation

L1 · Foundation

Foundation — Discounting, bond values, enterprise value and asset-based methods

Why value is the present value of future cash flows, valuing a bond with PVA and PV factors, the difference between enterprise value and equity value, and the three asset-based approaches — book value, replacement cost and break-up value.

22 min read · Worth 5% of the paper · Written from pages 221–251 of the official NISM workbook · Updated 18 September 2026

11.1 The one idea behind all valuation

Valuation of assets and businesses is an essential element of financial investments in businesses, financial markets and more specifically, in alternative investments.

Though there are several approaches, the most acceptable by theoretical standards is the one that estimates the value of an asset as the present value of its future cash flows. In theory therefore, the value of any financial investment is the Net Present Value (NPV) of its future cash flows i.e., Σ = NPV. This method is also known as the 'Discounted Cash Flow' or the DCF method of valuation.

Value of Asset = Future Cash Flow ÷ (1 + r)ⁿ, wherein (1+r)ⁿ represents the applicable discounting factor.

And the immediate caution:

Though the DCF appears to be a straight forward calculation, it is fraught with difficulty. The calculation is also extremely sensitive to the timing of any cash flow. The difference between receiving a cash flow at the start or the end of the year has material impact on NPV.

There are others such as asset based valuation, relative valuation and market based valuation but these approaches are used more to corroborate the fundamental value derived from cash flow based valuation.

Note that word corroborate. The workbook's position throughout is that DCF is the primary method and the others are cross-checks. Keep that hierarchy in mind — it decides several exam questions.

11.2 Valuing fixed income instruments

Fixed income instruments (debt securities) are the easier part of a valuation exercise as they provide predictable returns.

Why it matters for an AIF — three reasons:

a) AIFs that are floated as debt funds could invest in debt securities of investee companies and other entities such as SPVs, InvITs and REITs.

b) AIFs use debt structures in financing investee companies either as a complementary structure to equity financing or as convertibles that would become equity after set milestones are reached.

c) AIFs may also invest in debt securities in the listed or unlisted space to manage risk profile and liquidity of the scheme/fund.

The formula:

Value = I (PVA (r,n)) + F (PV (r,n))

Where I is the annual interest payable on the bond, F is the principal amount (par value) of the bond, r is the required return on the bond, and n is the maturity period.

The two factors are defined in the footnote and are worth learning:

PVA is the Present Value Annuity Factor... calculated as the annuity factor for 'n' time periods at a rate of return 'r' as PVA(n,r) = (1 - (1 + r)⁻ⁿ) / r
The PV factor is calculated as 1/(1+r)ⁿ

Illustration 11.1 — a bond trading below par

A INR 100 par value bond, bearing a coupon rate of 12 percent will mature after 8 years. The required rate of return on this bond is 14 percent.

V = INR 12 (PVA 14%, 8 yrs) + INR 100 (PV 14%, 8 yrs) = INR 12 (4.639) + INR 100 (0.351) = INR 90.77

In a spreadsheet: =PV(14%,8,12,100), where rate = the required rate of return; Nper = tenure of the bond; Pmt = coupon payments; Fv = future value of the bond.

Illustration 11.2 — a bond trading above par

A INR 1,000 par value bond, bearing a coupon rate of 14 percent, will mature after 5 years. The required rate of return on this bond is 13 percent.

V = INR 140 (PVA 13%, 5 yrs) + INR 1,000 (PV 13%, 5 yrs) = INR 140 (3.517) + INR 1,000 (0.543) = INR 1,035.4

Put the two illustrations side by side and the rule appears:

	Coupon	Required return	Value
Illustration 11.1	12%	14%	Rs 90.77 — below par
Illustration 11.2	14%	13%	Rs 1,035.4 — above par

When the required return exceeds the coupon, the bond is worth less than par. When the coupon exceeds the required return, it is worth more. That inverse relationship between yield and price is the whole of bond arithmetic in one line.

11.3 Why equity valuation needs a different approach

Similar approach as above can be used to estimate the value of an equity share in a company from an investor perspective using the present value of its expected dividend cash flow in future. However, this approach has limited relevance for alternative investments which are primarily made in unlisted companies that have high growth potential.

So, the emphasis here is not on distribution of profits but to generate high valuation with internal growth. Many of such investee companies may also lack sufficient distributable surplus. Therefore, there is a need to look at valuation of the business of the investee company to arrive at the valuation of its share.

The logic is worth following. A dividend discount model values the stream of dividends. But a venture-backed company pays no dividends — it reinvests everything — so a dividend model would value it at close to nothing. Hence the shift: value the business, then derive the value of the share.

11.4 The approaches to business valuation

Though several approaches to valuation are available... the ones that are mainly used are (i) the earnings approach based on DCF analysis (income approach), (ii) the relative valuation based on earnings multiples (market approach) and (iii) the asset based approach (cost approach).

Learn the three pairs of names, because the exam uses both terms:

Approach	Also called
Earnings approach based on DCF analysis	Income approach
Relative valuation based on earnings multiples	Market approach
Asset based approach	Cost approach

The ranking and its reasons:

The income or earnings based approach often scores over the other methods such as asset based methods (cost approach) and relative valuation based on market multiples. This is because the cost approach does not consider some critical drivers of value as the income approach. However, the income approach has several judgemental factors and assumptions to be made which make it quite subjective.

The use of relative valuation is tricky since it requires comparing 'an apple to an apple'. Therefore, the valuation could be misleading if comparable data is not available for a particular business. As such, when business models are unique or comparable data is not available, the relative valuation approach may not be appropriate.

Each method is criticised in its own terms: the cost approach misses value drivers, the income approach is subjective, and relative valuation needs true comparables.

The workbook's own chart adds two further approaches:

Economic Profit — Uses the economic profit of a company in a given period and measures value of the company. Under this approach, value is defined as the sum of the present capital employed and the present value of the projected economic profit for the future.
Contingent Claim Valuation — Uses option pricing models in cash flow based valuation to factor in embedded real options.

And under Income or Earnings: Value can be estimated either using firm cash flow or equity cash flow and discounting it appropriately. This method is known as the DCF method. Earnings capitalisation method may also be used as an alternative, though DCF methodology is more comprehensive.

11.4.1 Enterprise Value and Equity Value

This distinction underlies every valuation question in the chapter, so get it exactly right.

Enterprise Value (EV) is the value generated by the business regardless of whether it is financed by debt or by own cash (meaning equity). Enterprise value (EV) is measured with reference to the earning potential (gross operating cash flow) which in profit terms refers to the earnings before interest, tax, depreciation and amortisation (EBITDA) and reflects the estimate of the value of the business regardless of how it is financed. Therefore, EV is the value of the total capital in the company or business regardless of whether it is debt or equity capital.

Equity value or market capitalisation (market value of a listed company) is the value of 100% of the shares of the company (total equity capital). It measures the total value of funds belonging to equity shareholders in the company after all other [claims] on the business, including debt and preference capital have been deducted.

The bridge:

Enterprise Value (EV) = Equity Value (Market Cap) + Total Debt (net of cash) + Preference capital (if any)

Illustration 11.3

Company's estimated Market Cap = INR 1000 crore
Long Term Debt on the balance sheet = INR 200 crore
Outstanding Preference Capital = INR 50 crore
Cash on the balance sheet = INR 5 crore
Enterprise Value = 1000 + (200−5) + 50 = INR 1245 crore

Note the two details that trip candidates up. Debt is taken net of cash — Rs 200 crore less Rs 5 crore — because cash could repay debt. And preference capital is added, since it is part of the total capital of the business even though it is not equity.

And the reverse direction, which is how DCF works:

relative valuation methods determine the Enterprise value. In order to arrive at the Equity Value, the book value or market value of outstanding debt has to be deducted from the Enterprise Value.

EV → deduct debt → Equity Value → divide by shares → value per share. That is the last three steps of every valuation in this chapter.

11.5 Asset based valuation — three approaches

Under this method, the value of the equity share of a company is arrived at as the 'net asset value' per share, i.e. the total net asset value of the company is divided by the number of outstanding shares in the company to arrive at the value per share. This method does not take into account any future value attributable to the business and considers only the market value of the assets less liabilities of the company.

Asset based valuation can be done from three approaches – (1) Book Value or Net Asset Value (NAV) approach, (2) Replacement Cost approach and (3) Break-up Value approach.

1. Book value / NAV approach

Under the first method, all the assets and liabilities of the company as on the valuation date are considered at historical carrying cost in the books. If the assets and liabilities are considered only at their balance sheet values (known as 'historical cost'), then we will arrive at the 'book value' per share of the company.

Book value of share of a company is normally considered the 'floor price' or the least value attributable to a 'going concern' business which is expected to continue in business in future.

Book value = the floor price for a going concern. Remember that phrase.

Book Value per Share = Equity Shareholders' funds as per balance sheet ÷ No. of equity shares issued and paid up

2. Replacement cost approach

Under the second method, the value of the business is estimated at the cost of replacement of the entire business on as-is-where-is basis. Essentially, the market cost of the assets and liabilities with suitable adjustments for their current position are considered. In addition to the cost of acquisition of the assets, the costs related to establishment of the business as a going-concern in its present state are considered.

This method is appropriate for businesses that have high entry barriers or setting up costs.

Note the two components: the market cost of assets and liabilities, plus the costs related to establishment of the business as a going-concern — licences, registrations, pre-operative costs.

3. Break-up value approach

The third method considers the salvage value of a business if it were shut down on the valuation date. Therefore, this method is also known as the 'break-up value' method since it measures the current market value of the company if it is broken up and sold in individual pieces of assets. Break-up value method is used to value a company that is in distress or does not have a future business case.

Break up Value per Share = (Liquidation Value of Assets – Settlement Value of Debt) ÷ No. of equity shares issued and paid up

Illustration 11.4 — the three values compared

Alpha Ltd's balance sheet totals Rs 2,00,00,000, with 10,000 shares. Adjustments given: fixed assets 10% lower on a going concern basis but only 40% of book value if scrapped; inventory would cost 10% higher in the market; receivables would fetch 25% lower than book value on liquidation; market value of payables would be 15% lower on liquidation; an additional INR 20,00,000 as setting up costs; and intangibles would fetch INR 5 lakh more if they were sold.

I. Book Value. Equity capital Rs 1,00,000 plus cash reserves of Rs 1,00,00,000 (general reserve Rs 50,00,000, capital redemption reserve Rs 25,00,000, debenture redemption reserve Rs 20,00,000, P&L surplus Rs 5,00,000) gives tangible net worth of Rs 1,01,00,000 and NAV per share of Rs 1,010.

A footnote carries an important accounting point: Cash networth does not include revaluation reserve. Hence it is excluded from valuation. A revaluation reserve is a book-keeping entry recognising that assets are worth more than cost; it is not cash and never was.

II. Break-up Value. From tangible net worth of Rs 1,01,00,000, add appreciation in stock and intangible assets and reduction in payables (3.5L+5L+1.5L) = Rs 10,00,000 and less depreciation in scrap value of fixed assets and receivables (72L+6.25L) = Rs 78,25,000, giving Rs 32,75,000 and a break-up value per share of Rs 327.50.

III. Replacement Value. From book value of assets of Rs 2,00,00,000, add appreciation in stock, intangibles (3.5L+5L) = Rs 8,50,000, add additional setting up costs Rs 20,00,000, and less depreciation in fixed asset value on going concern basis Rs 12,00,000, giving a Replacement Value of business (Enterprise Value) of Rs 2,16,50,000.

Note carefully which is which: the break-up value gives an Equity Value; the replacement value gives an Enterprise Value. That is because break-up value has already settled the debt, while replacement value is the cost of putting the whole business back on its feet.

The verdict on asset-based valuation

Asset based valuation is not considered an independent method and when it is employed, it would more often than not be used in conjunction with other methods assigning appropriate weightage based on its overall importance in the given valuation context. As mentioned above, it is most appropriate for asset heavy businesses and distressed companies facing liquidation. It is also ideal for financial businesses such as banks and financial or investment companies.

Three situations where it fits: asset heavy businesses, distressed companies facing liquidation, and financial businesses such as banks and investment companies. For a software company with three engineers and a laptop, it is meaningless.

Think of it like this

The mango tree valued by its fruit, not by its timber

Ask two people what a mango orchard is worth. The timber merchant adds up what the wood would fetch if every tree were cut. The farmer works out thirty more years of harvests and asks what that stream of crops is worth today.

Both are legitimate answers to different questions, and the workbook is clear about which one it prefers: the most acceptable by theoretical standards is the one that estimates the value of an asset as the present value of its future cash flows. The timber merchant's figure — the break-up value — is used to value a company that is in distress or does not have a future business case.

And the farmer's figure is fragile in a particular way: The calculation is also extremely sensitive to the timing of any cash flow. The difference between receiving a cash flow at the start or the end of the year has material impact on NPV.

The old fixed deposit certificate in a market of new rates

Your uncle holds an eight-year FD receipt paying 12 per cent. Today banks pay 14 per cent. If he wants to sell that receipt to someone, will he get face value? Of course not — the buyer can get 14 per cent elsewhere, so he will only take the 12 per cent paper at a discount.

Reverse it. A receipt paying 14 per cent when the market offers 13 per cent will sell for more than face value.

That is exactly what the two illustrations show. A 12 per cent bond with a 14 per cent required return is worth Rs 90.77 against a par of Rs 100. A 14 per cent bond with a 13 per cent required return is worth Rs 1,035.4 against a par of Rs 1,000.

Value = I (PVA (r,n)) + F (PV (r,n)) is only that intuition written down.

The price of the shop versus the price of the shop minus its loan

A shopkeeper says his shop is worth Rs 80 lakh. A buyer asks a different question: what will I actually pay the owner? If the shop carries a Rs 30 lakh bank loan the buyer must clear, and Rs 2 lakh sits in the till, the owner walks away with far less than Rs 80 lakh.

The shop itself is the Enterprise Value — the value of the total capital in the company or business regardless of whether it is debt or equity capital. What the owner keeps is the Equity Value — the total value of funds belonging to equity shareholders in the company after all other [claims] on the business, including debt and preference capital have been deducted.

Enterprise Value (EV) = Equity Value (Market Cap) + Total Debt (net of cash) + Preference capital (if any). Note net of cash, because the cash in the till can go straight against the loan.

Three ways to price a family printing press

An old printing press in Pune can be priced three ways.

Ask the accountant and he opens the books: machines at cost less depreciation, minus what is owed. That is book value, and it is normally considered the 'floor price' or the least value attributable to a 'going concern' business.

Ask what it would cost to build the same press today — buy the machines, take the licences, get the pollution clearance, hire and train the men. In addition to the cost of acquisition of the assets, the costs related to establishment of the business as a going-concern in its present state are considered. That is replacement cost, appropriate for businesses that have high entry barriers or setting up costs.

Ask the scrap dealer what he would pay if the press shut tomorrow. That is break-up value — the current market value of the company if it is broken up and sold in individual pieces of assets — used to value a company that is in distress or does not have a future business case.

Same press. Three legitimate numbers. The right one depends on what you are asking.

The revaluation reserve is a boast, not a bank balance

A family revalues its ancestral house from the Rs 4 lakh it cost in 1972 to the Rs 3 crore it is worth today, and writes the difference proudly in the family ledger. Nothing has entered the family's bank account. Nobody can spend that entry.

That is why the workbook's footnote to Illustration 11.4 strikes out one line: Cash networth does not include revaluation reserve. Hence it is excluded from valuation.

The other reserves in that balance sheet — general reserve, capital redemption reserve, debenture redemption reserve, P&L surplus — all represent profits actually earned and retained. The revaluation reserve represents an opinion about a price. In a valuation exercise, the opinion is what you are producing, not what you are counting.

Judging a restaurant by its kitchen rather than by the owner's loan

Two identical restaurants, same footfall, same menu, same profit from operations. One owner bought his premises with a big loan and pays heavy interest; the other inherited his. Look only at the final profit and the first looks like a failing business.

That is exactly the case for the EBITDA multiple: The advantage of using the EBITDA (Earnings before Interest, Tax, Depreciation and Amortisations) in the place of PAT is that EBITDA is a measure of operational efficiency.

And there is a sharper case: in companies where the EBITDA is positive but the profit after tax (PAT) is negative (due to high interest, depreciation and amortisation burden), this multiple provides a better measure of value. This can happen in the case of businesses with long gestation to break-even and profits such as in start-up companies in growth phase or asset heavy businesses.

A P/E ratio on a loss-making company is a meaningless number. An EV/EBITDA multiple still says something about the kitchen.

Key terms in this chapter

Adjusted NAV: The fund's NAV after deducting taxes and statutory payments, outstanding fees and expenses, carried interest and other contractual deductions — equivalent to the cash investors would receive if all portfolio assets were realised at the valuation date.
Alternative Investment Policy Advisory Committee (AIPAC): SEBI's committee whose recommendations an AIF industry association must take into account before endorsing valuation guidelines for securities not covered by mutual fund valuation norms.
Bond Valuation Formula: Value = I (PVA(r,n)) + F (PV(r,n)), where I is annual interest, F the par value, r the required return and n the maturity period. Where the required return exceeds the coupon the bond is worth less than par, and vice versa.
Book Value (NAV) Approach: Assets and liabilities taken at historical carrying cost, giving equity shareholders' funds divided by shares issued and paid up. Book value is normally considered the floor price for a going concern business.
Bottom-up Approach (Fund NAV): Also called sum of parts valuation — the fund's NAV is the sum of the estimated fair values of its underlying portfolio investments as at the valuation date.
Break-up Value Approach: The salvage value if the business were shut down on the valuation date — liquidation value of assets less settlement value of debt, divided by shares. Used for a company in distress or without a future business case.
Capital Asset Pricing Model (CAPM): Cost of Equity = Rf + Equity beta × (ER − Rf). It produces a required rate of return, not a value, combining the risk-free rate with the company's systematic risk multiplied by the market risk premium.
Change of Valuation Methodology: A change of methodology or approach within the prescribed valuation guidelines is not construed as a material change and so triggers no exit option, but valuations on both the old and the new methodologies must be disclosed to investors.
Deal Comps and Trading Comps: Earnings based multiples, also called transaction comparables or deal comps, chiefly EV/EBITDA and EV/Sales; and market based multiples, also called trading comps, chiefly the P/E and P/BV ratios.
Discounted Cash Flow (DCF): The method that estimates the value of an asset as the present value of its future cash flows, discounted at the weighted average cost of capital. Theoretically the strongest approach, but extremely sensitive to the timing of cash flows and to the assumptions made.
Enterprise Value (EV): The value of the total capital in a business regardless of whether it is debt or equity, measured by reference to EBITDA. EV equals equity value plus total debt net of cash plus preference capital.
Equity Beta: The volatility of the return on a company's stock relative to the return on the market. It scales the market risk premium in the CAPM.
Equity Value: The value of 100 per cent of the shares — market capitalisation in a listed company — being the funds belonging to equity shareholders after all other claims including debt and preference capital have been deducted.
EV/EBITDA Multiple: Value of firm divided by EBITDA. The higher the multiple the higher the value. EBITDA is preferred to PAT because it measures operational efficiency and remains meaningful where interest, depreciation and amortisation make PAT negative.
Fair Value: The arm's length price agreed between an unconnected willing buyer and seller — under IND-AS 113, the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
First Chicago Method: A variation of the VC method in which best, worst and survival scenarios are each valued and then weighted to produce a weighted average valuation, which is discounted to present value to determine the stake.
Free Cash Flow: Operating cash flow — PAT plus depreciation and other non-cash charges, adjusted for changes in working capital — less reinvestment requirements such as ongoing capital expenditure and long-term debt repayments.
Gross Merchandise Value (GMV): The combined value of all goods sold by vendors through an e-commerce platform. It is not revenue — the portal earns only a small percentage of GMV — and is typically capitalised at 2 to 5 times in valuing loss-making e-commerce businesses.
Illiquidity Premium and Discount: Because unlisted stock cannot be readily sold, the cost of equity of an unlisted company is higher than a comparable listed company's, and a discount is applied to quoted market multiples when valuing unlisted stock. The discount may be reduced if an exit is believed imminent.
Independent Valuer Eligibility: The valuer must not be an associate of the manager, sponsor or trustee, must have at least three years' experience in valuing unlisted securities, and must be registered with the IBBI with ICAI, ICSI, ICMAI or CFA Institute membership — or be a holding company or subsidiary of a SEBI-registered credit rating agency.
IPEV Guidelines: The International Private Equity and Venture Capital Valuation Guidelines, providing principles-based valuation guidance for the private equity and venture capital industry, with fair value as their central theme and alignment with the IVSC's International Valuation Standards.
Option Pricing Method (OPM): A forward-looking early-stage technique that takes the current equity value and allocates it across classes of equity considering a continuous distribution of outcomes, rather than a small number of distinct future scenarios.
Present Value Annuity Factor (PVA): The factor used to value a stream of equal periodic payments, calculated as (1 − (1 + r)⁻ⁿ) / r. The plain present value factor for a single future sum is 1/(1+r)ⁿ.
Price of Previous Transaction Method: Using the pricing of a follow-on investment as the implied market value of the whole holding. A first investment is carried at cost initially and revised thereafter on the basis of follow-on transaction pricing.
Price to Book Value Multiple: Value of firm divided by net worth, where net worth is share capital plus accumulated reserves. Around 4 to 5 times book value is considered healthy for a listed company, but the multiple cannot be used where accumulated losses have made book value negative.
Relative Valuation: Valuing on the basis of standardised multiples derived from current market prices or recent transactions, enabling inter-firm comparison. It is easier to explain than DCF but ignores future capex and working capital, needs mature comparables, involves subjective multiple selection, and moves with external factors.
Replacement Cost Approach: Valuing the business at the cost of replacing it on an as-is-where-is basis — the market cost of assets and liabilities plus the cost of establishing the business as a going concern, such as licences and pre-operative costs. Appropriate for businesses with high entry barriers or setting-up costs.
Revaluation Reserve Exclusion: A revaluation reserve represents an upward restatement of asset values rather than profits earned, so it is excluded from cash net worth when computing book value for valuation purposes.
Specific Company Risk Premium (SCRP): An additional premium analysts add to the discount rate for start-ups, reflecting unsystematic risks such as absence of track record, losses, private funding, high mortality and illiquidity, over and above the systematic risk captured by beta.
Terminal Growth Rate (g): The expected growth rate of profit after the discrete forecast period. For consolidated industries it is normally taken 2 to 3 per cent above the inflation rate; high growth or sunrise industries can justify higher rates.
Terminal Value: The continuing value of free cash flow beyond the discrete forecast period, computed to perpetuity as FCF(T+1) divided by (WACC − g). In young companies it can influence the value of shares almost all by itself.
Valuation of Non-performing Debt: Collateralised non-performing debt is valued on the collateral, the risk of converting it into cash and the time required to do so. Uncollateralised or restructuring debt is valued on the most likely cash flows discounted at a market purchaser's cost of capital for such distressed debt.
Venture Capitalist Method: Estimating the firm's terminal value at expected exit, discounting it at the hurdle rate, and computing the stake as investment proposed divided by post-money valuation — with an upward adjustment for the dilution factor expected from future fund raising.
Weighted Average Cost of Capital (WACC): The post-tax cost of debt and the cost of equity weighted by their proportions in the capital structure. It is the discount rate used in a DCF model and the denominator input in the terminal value formula.

Check you have understood it

The L1 test for this chapter has 9 questions. Score 60% to unlock L2 Application (worked numericals and scenarios) and then L3 Exam-Ready (NISM-style traps, timed, with this paper's real marking). Tests, the higher levels and full mock exams need a free account so we can track your progress.

Create a free account

Original explanatory writing based on the official NISM workbook for Series XIX-A, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

Something look wrong? Report it