NISM Series XIX-E · Chapter 12: Valuation

L1 · Foundation

How Value Is Measured - Businesses, Bonds and a Fund's NAV

Why value is the present value of future cash flows, how bonds are valued, why AIFs value the business rather than the dividend, enterprise value against equity value, the three asset-based methods, the DCF steps, relative valuation multiples, and what NAV, Valuation Day, classes of units, series and mark-to-market mean for a Category III AIF.

16 min read · Worth 10% of the paper · Written from pages 295–343 of the official NISM workbook · Updated 18 September 2026

How Value Is Measured

12.1 The one idea behind all valuation

Every valuation method in this chapter is trying to answer one question: what is this asset worth today?

The workbook says the approach "most acceptable by theoretical standards" is to treat value as the present value of future cash flows. In theory, the value of any financial investment is the Net Present Value (NPV) of its future cash flows. This is the Discounted Cash Flow (DCF) method.

Value of Asset = Sum of Future Cash Flows / (1 + r)^n

r is the applicable discounting rate
n is the number of periods over which that rate is applied

Other methods exist - asset based, relative and market based valuation. The workbook says these are used more to corroborate the fundamental value that comes from cash-flow based valuation. They are cross-checks, not the main event.

12.2 Valuing fixed income instruments

Debt securities give predictable returns, so they are the easiest place to start. Why should an AIF manager care? The workbook gives three reasons:

AIFs floated as debt funds may invest in debt securities of investee companies and other entities such as SPVs, InvITs and REITs.
AIFs use debt structures to finance investee companies - either alongside equity, or as convertibles that become equity after set milestones.
AIFs may hold listed or unlisted debt to manage the risk profile and liquidity of the scheme.

A bond paying periodic interest is valued as:

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

Symbol	Meaning
I	Annual interest payable on the bond
F	Principal amount (par value)
r	Required return on the bond
n	Maturity period
PVA	Present Value Annuity factor = (1 - (1 + r)^-n) / r
PV	Present value factor = 1 / (1 + r)^n

In plain words: the interest is a stream of equal payments, so it is valued with the annuity factor. The principal comes back once, at the end, so it is valued with the single-sum factor. The two are added.

12.3 Why AIFs do not value equity by its dividends

You could value a share the same way - as the present value of its expected dividends. The workbook says this has limited relevance for alternative investments, for two reasons:

AIFs invest mainly in unlisted companies with high growth potential. The aim is not distribution of profits but building high valuation through internal growth.
Many investee companies lack sufficient distributable surplus in any case.

So an AIF must value the business of the investee company first, and derive the value of its share from that.

12.4 The approaches to business valuation

Three approaches are mainly used:

Approach	Also called	Based on
Earnings approach	Income approach	DCF analysis
Relative valuation	Market approach	Earnings multiples
Asset based approach	Cost approach	The company's assets

Why the income approach usually wins. The cost approach does not consider some critical drivers of value that the income approach does.

Its weakness. The income approach needs many judgemental factors and assumptions, which make it quite subjective.

The catch with relative valuation. It requires comparing "an apple to an apple". When a business model is unique or comparable data is not available, relative valuation may be misleading and may not be appropriate.

The workbook's overview chart (from Pratap Giri S., Investment Banking, McGraw Hill 2017) lists these families:

Family	What it does
Income or earnings (DCF)	Uses future expected earnings to measure the Free Cash Flow, using either firm cash flow or equity cash flow, discounted appropriately. Earnings capitalisation may be used as an alternative, though DCF is more comprehensive
Economic profit	Value = present capital employed + present value of projected economic profit
Relative valuation	Uses market multiples - either trading multiples or prevailing transaction multiples
Contingent claim valuation	Uses option pricing models within cash-flow valuation to capture embedded real options
Asset based valuation	Uses existing assets as the base. Not considered by many as an independent method

12.4.1 Enterprise value and equity value

Two different "values" of the same company. Mixing them up is a common exam error.

Enterprise Value (EV) is the debt-free / cash-free value of the operating business. It is linked to earning potential - EBITDA - and is the value regardless of how the business is financed. It is the value of total capital, debt and equity together.
Equity Value (for a listed company, market capitalisation) is the value of 100% of the shares. It is what belongs to equity shareholders after debt and preference capital have been deducted.

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

12.5 Asset based valuation - three versions

Here, a share is worth its net asset value per share: total net assets divided by outstanding shares. The method ignores any future value of the business. It looks only at assets less liabilities.

Version	What it measures	When it fits
(1) Book Value / NAV	Assets and liabilities at historical carrying cost in the books	Normally the "floor price" - the least value of a going concern
(2) Replacement Cost	Cost of replacing the entire business as-is-where-is: market cost of assets, plus the cost of establishing it as a going concern	Businesses with high entry barriers or setting-up costs
(3) Break-up Value	Salvage value if the business were shut down on the valuation date and sold piece by piece	Companies in distress or with no future business case

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

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

12.6 DCF valuation, step by step

The DCF method finds the present value of a company's free cash flow, discounted at its Weighted Average Cost of Capital (WACC).

Forecast free cash flow for a period of about 5 years. Start from operating cash flow: OCF = PAT + Depreciation +/- Non-cash charges +/- Changes in working capital. Then subtract reinvestment requirements - ongoing capex and working capital investment - and any long-term debt repayment.
Add a terminal value for everything after the forecast period: Terminal Value = FCF(T+1) / (WACC - g), where g is the expected growth rate after the discrete period.
Work out the WACC: post-tax cost of debt and cost of equity, weighted by their share in the capital structure.
Discount the FCF and the terminal value. Their sum is the Enterprise Value. Deduct outstanding debt to get equity value. Divide by outstanding shares to get value per share.

Two points that matter for AIFs:

Cost of equity usually starts from CAPM, then adds an illiquidity premium for alternative assets and any specific risk premium. So an unlisted company's cost of equity is higher than a comparable listed company's.
Terminal growth rate. For consolidated industries it is normally 2-3% above inflation - so at 3% inflation, about 5-6%. Sunrise industries can justify higher rates. In young companies the terminal growth rate influences the value almost all by itself - which is why VC and PE investors must watch it closely.

12.7 Relative (multiple based) valuation

Relative valuation says assets should be valued on the basis of their current market price, using standardised multiples that allow comparison between firms. It is popular because it is easier to explain and less quantitative than DCF.

Its four disadvantages, in the workbook's list:

(a) It ignores future capital expenditure and incremental working capital needs
(b) It suits only companies that have reached maturity and are stable
(c) The selection of multiples is subjective
(d) Multiples are driven by external factors, which can change a valuation with no shift in intrinsic value

Two families of multiples:

Family	Also called	Common examples
Earnings based multiples	Transaction Comparables / Deal Comps	EV/EBITDA, EV/Sales (the "topline multiple")
Market based multiples	Trading Comps	P/E ratio, P/BV ratio

The P/E ratio is the most widely used market multiple. But unlisted firms have no market price, so trading comps are quite unsuitable for them - at best, multiples of listed surrogates are borrowed.

EV/EBITDA. The higher the multiple, the higher the value. EBITDA is used instead of PAT because it measures operational efficiency. It also works when EBITDA is positive but PAT is negative - common in start-ups in the growth phase and asset heavy businesses with long gestation.

Price to Book Value. Shows how many times book value a company is valued at. In listed companies, a market cap of 4-5 times book value is usually considered healthy. It cannot be used where book value could be negative - start-ups and technology companies.

P/E. Uses the current market price, so it gauges value as a multiple of current earning capacity. It can also compare unlisted companies with listed peers. Other variations are the PAT multiple and the EBIT multiple.

12.8 Net Asset Value - how a fund is valued

A Category III AIF is a pool. Its NAV per unit is what each unit is worth.

Two rules from the SEBI (AIF) Regulations:

NAV calculation must be independent from the fund management function.
NAV must be disclosed quarterly for closed-ended AIFs and monthly for open-ended AIFs. Investors also get a description of the valuation procedure, methodology and any changes.

Valuation Day

The day by reference to which NAV is determined. It is pre-determined and stated in the offer documents. It can be set in one or more ways:

At least once a calendar month (open-ended) or at least once a quarter (closed-ended), as on the last Business Day. A fund investing only in listed securities usually computes NAV daily.
At the close of business of the last securities market on every Business Day on which the fund trades - for Mark-to-Market.
At intervals set by the Investment Manager for a closing, redemption or distribution.

Class of Units and Series

The number of units an investor holds decides his Beneficial Interest - the basis for allocations and distributions.

A fund may give differential rights to groups of investors, based on the size of commitment, the time period of commitment and its share of the total corpus. It does this by issuing different Classes of Units - for institutional investors, the sponsor, the manager's employees and others. How units are classed is at the manager's discretion.

A Series is a distinct group within one Class, used to identify different sets of investors in the same class.

The NAV formula

NAV per unit = (Assets attributable to the class - liabilities, contingencies, losses and expenses attributable to it) / units issued, rounded up to four decimal places. NAV is calculated separately for each class or series.

Mark-to-Market (MTM)

MTM means valuing every security at its fair market value on each Valuation Day, so NAV shows the portfolio's "true worth" that day. Without it, holdings - especially unlisted ones - would stay at cost.

MTM matters for three reasons:

Incentive fees are based on returns at current prices, so MTM fixes the fair fee payable.
It ensures fair redemption - units are redeemed at the MTM NAV.
Category III AIFs use derivatives, so daily MTM is needed to reconcile margin accounts with brokers.

Think of it like this

A mango orchard is worth its future mangoes, not its soil

A farmer in Ratnagiri is offered money for his Alphonso orchard. What should he accept? Not the price of the land alone - the buyer is really paying for the mangoes the trees will give over the coming years. A crate next summer is worth a little less than a crate today, and a crate ten summers away is worth much less. So he adds up the future harvests, each shrunk by how far away it is. That is DCF: value is the sum of future cash flows, each divided by (1 + r)^n. And, just as the workbook warns, timing matters - a harvest that comes in April rather than June changes the answer.

Three prices for the same dhaba

A highway dhaba can be valued three ways. Its account book shows what the tandoor, tables and building cost years ago - that is book value, the floor for a business that will keep running. A rival asks what it would cost to set up the same dhaba today, including the FSSAI licence and months of getting it going - that is replacement cost, which matters most where entry is hard. If the owner shuts down and sells the tandoor to a scrap dealer and the chairs one by one, he gets break-up value - the number that matters only when the business has no future.

Enterprise value is the house, equity value is what the seller keeps

Mr Iyer sells a flat for ₹1 crore that still has a ₹30 lakh home loan on it. The buyer is paying for the whole flat - that is the enterprise value, the value of the asset however it was financed. Mr Iyer pockets only what is left after the bank is paid off - that is the equity value. If he also leaves ₹5 lakh of cash in the cupboard for the buyer, the loan is effectively ₹25 lakh net of cash. Hence EV = equity value + debt net of cash (+ preference capital).

Relative valuation is pricing a flat by its neighbours

In a large housing society in Pune, a 2BHK is easy to price: three identical flats sold last month, so you know the rate per square foot. That is relative valuation - quick, easy to explain, and based on current market prices. Now try pricing the only bungalow on the hill with a private temple. There is no comparable, so the "rate per square foot" from the society flats would badly mislead you. The workbook says exactly this: relative valuation needs an apple-to-apple comparison, and fails for unique business models.

Classes of units are coaches on the same train

Every passenger on the Rajdhani reaches Delhi at the same time - it is one train, one journey. But the AC first-class passenger and the AC three-tier passenger paid different fares. A Category III AIF with several classes of units works the same way: one underlying portfolio, but different management and incentive fees for different classes. So the NAV per unit is calculated separately for each class or series, because what each passenger has left in his pocket at the end is different.

Key terms in this chapter

Amortised cost: The purchase cost of a debt security adjusted for any discount or premium over its remaining life. Used for unlisted securities with no ascertainable market, plus accrued interest.
Book Value per Share: Equity shareholders' funds as per the balance sheet divided by the number of equity shares. Normally considered the floor price of a going concern.
Break-up Value: The salvage value of a business if it were shut down and its assets sold piece by piece: (liquidation value of assets - settlement value of debt) / shares. Used for companies in distress or with no future business case.
Class of Units: A group of units carrying differential rights - such as different management or incentive fees - issued to a class of investors based on the size and timing of their commitments. Classes are set at the manager's discretion.
Discounted Cash Flow (DCF) method: Valuing an asset as the net present value of its future cash flows, discounted at an applicable rate. The workbook calls it the most acceptable approach by theoretical standards, but extremely sensitive to the timing of cash flows.
Enterprise Value (EV): The debt-free, cash-free value of the operating business - the value of total capital regardless of how it is financed. EV = Equity Value + Total Debt (net of cash) + Preference capital.
Equity Value: The value of 100% of a company's shares - what belongs to equity shareholders after debt and preference capital are deducted. For a listed company, its market capitalisation.
EV/EBITDA multiple: Value of firm divided by EBITDA. EBITDA measures operational efficiency, and the multiple still works where EBITDA is positive but PAT is negative, as in start-ups or asset-heavy businesses.
Free Cash Flow: Operating cash flow (PAT + depreciation +/- non-cash charges +/- working capital changes) less reinvestment requirements such as ongoing capex and working capital, and any long-term debt repayment.
Illiquid security: A security with few buyers and sellers and small daily volumes, which may not be saleable at its screen price. The workbook values it by discounting the expected sale proceeds over the days needed to sell.
Independent valuer: The valuer a Category III AIF must use for unlisted securities and listed debt. Not an associate of the manager, sponsor or trustee; at least 3 years' experience; and either an IBBI-registered valuer with ICAI, ICSI, ICMAI or CFA Institute membership, or a holding company or subsidiary of a SEBI-registered credit rating agency.
Leverage (Category III AIF): Total exposure (long plus short positions, after permitted offsetting) divided by NAV. Capped at 2 times NAV, with prior investor consent and periodic disclosure. Idle cash is excluded from exposure.
Mark-to-Market (MTM): Valuing every security in the portfolio at its fair market value on each Valuation Day, so NAV shows the portfolio's true worth. Needed for fair incentive fees, fair redemptions and daily margin reconciliation on derivatives.
Net Asset Value (NAV) of a Category III AIF: Assets attributable to a class or series of units, less liabilities, contingencies, losses and expenses attributable to it, divided by units issued, rounded to four decimal places. Disclosed quarterly for closed-ended and monthly for open-ended funds.
Off-balance sheet exposure: Exposure through leverage or derivatives that is not a direct obligation of the fund, though the fund indirectly bears its risks and returns.
Opening Series NAV: The Series NAV on the Valuation Day just before the current one. For a new series on its first Valuation Day, it equals the amount drawn down for that series.
Present Value Annuity factor (PVA): The factor used to value a stream of equal periodic payments, calculated as (1 - (1 + r)^-n) / r.
Relative valuation: Valuing assets on the basis of current market prices, using standardised multiples that allow comparison between firms. Easier to explain than DCF, but it needs truly comparable companies.
Replacement Cost approach: Valuing a business at what it would cost to replace it as-is-where-is, including the cost of establishing it as a going concern. Suits businesses with high entry barriers or setting-up costs.
Required return (on a bond): The rate at which a bond's coupons and principal are discounted to find its value. If it is above the coupon, the bond is worth less than par.
Series NAV: Series Assets less Series Liabilities and Series Expenses on a Valuation Day, divided by units in that series, rounded to four decimal places. Common items are shared in proportion to Opening Series NAV.
Series (of units): A distinct and exclusive group of units within one class, used to identify different investors in that class and to calculate a Series NAV.
Terminal Value: The value of cash flows after the forecast period, calculated to perpetuity as FCF(T+1) / (WACC - g). In young companies the terminal growth rate can drive the valuation almost by itself.
Trading Comps: Market based multiples such as the Price-Earnings ratio and the Price-Book Value ratio. Quite unsuitable for unlisted companies, which have no market price.
Transaction Comparables (Deal Comps): Earnings based multiples such as EV/EBITDA and EV/Sales (the topline multiple).
Valuation Day: The pre-determined day, stated in the offer documents, by reference to which NAV is calculated - at least monthly for open-ended and at least quarterly for closed-ended Category III AIFs.
Volume Weighted Average Yield (VWAY): The yield used to value debt. T-bills and G-Secs use trades in the last one hour; all other money market and debt securities use all trades during the day.
Weighted Average Cost of Capital (WACC): The discount rate in a DCF valuation: post-tax cost of debt and cost of equity, each weighted by its share of the capital structure.

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

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