NISM Series XIX-C · Chapter 14: Valuation

L1 · Foundation

Foundation — Valuing a bond, a business and a share

The present-value principle behind all valuation, bond valuation with the annuity factor, the difference between Enterprise Value and Equity Value, the three asset-based approaches, the four steps of a DCF including WACC and terminal value, and the EV/EBITDA, P/BV and P/E multiples.

28 min read · Worth 7% of the paper · Written from pages 366–424 of the official NISM workbook · Updated 18 September 2026

14.1 The one principle underneath everything

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. This method is also known as the 'Discounted Cash Flow' or the DCF method of valuation.

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

where r represents the applicable discounting rate; n represents the number of periods over which the discounting rate is applied.

And immediately, the honest 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 other methods 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.

That word corroborate sets the hierarchy for the whole chapter: cash flow valuation is primary; the others check it.

14.2 Valuing a fixed income instrument

Fixed income instruments or debt securities provide predictable returns. Fixed income valuation is applicable in an AIF context for three reasons:

AIFs that are floated as debt funds could invest in debt securities of investee companies and other entities such as SPVs, InvITs and REITs.
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.
AIFs may also invest in debt securities in the listed or unlisted space to manage risk profile and liquidity of the scheme / fund.

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, from the footnote: PVA is the Present Value Annuity Factor... PVA(n,r) = (1 − (1 + r)⁻ⁿ) / r. And the PV factor is calculated as 1/(1+r)ⁿ.

Illustration 14.1

A INR 100 par value bond, bearing an annual 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

This can be solved in a spreadsheet using the PV function as follows: =PV(14%,8,12,100)

Illustration 14.2

A INR 1,000 par value bond, bearing an annual 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

Notice the pattern, which is worth internalising rather than memorising: in the first case the required return (14%) exceeds the coupon (12%), so the bond trades below par at INR 90.77. In the second the coupon (14%) exceeds the required return (13%), so it trades above par at INR 1,035.40.

14.3 Why equity valuation for AIFs is different

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.

That is the pivot of the chapter. A dividend discount model is useless on a company that pays no dividends and does not intend to. So you value the business, then work back to the share.

14.4 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).

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.

The workbook's overview chart names four families:

Approach	What it uses
Income or Earnings	Uses the future expected earnings to measure the Free Cash Flow of the company... known as the DCF method. Earnings capitalisation method may also be used as an alternative, though DCF methodology is more comprehensive.
Economic Profit	Uses the economic profit of a company in a given period... value is defined as the sum of the present capital employed and the present value of the projected economic profit for the future.
Relative Valuation	Uses different types of market multiples. These are either trading multiples or prevailing transaction multiples.
Contingent Claim Valuation	Uses option pricing models in cash flow based valuation to factor in embedded real options.
Asset based Valuation	Uses existing assets as a base for valuation. Not considered by many as an independent method.

14.4.1 Enterprise Value versus Equity Value

Enterprise value (EV) is the debt-free/cash free value of the operating business. 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, including debt and preference capital, have been deducted.

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

Illustration 14.3

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 arithmetic on debt: net of cash, so INR 200 crore of debt less INR 5 crore of cash = INR 195 crore.

EV is what the whole business is worth. Equity Value is what is left for shareholders after debt and preference capital. Every relative-valuation multiple in this chapter delivers one or the other, and confusing them is the single commonest error in the topic.

14.5 Asset based Valuation

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. 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

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.

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

2. Replacement Cost approach

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.

3. Break-up Value approach

This method considers the salvage value of a business if it were shut down on the valuation date... 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

The Alpha Ltd illustration — and one crucial exclusion

Illustration 14.4 works all three on the same balance sheet. In the book value computation, share capital of INR 1,00,000 is added to cash reserves of general reserve INR 50,00,000, CRR INR 25,00,000, DRR INR 20,00,000 and P&L surplus INR 5,00,000 to give a tangible net worth of INR 1,01,00,000 and, on 10,000 shares, an NAV per share of INR 1,010.

The footnote carries the trap: cash networth does not include REVALUATION RESERVE. Hence it is excluded from valuation. The balance sheet showed a revaluation reserve of INR 15,00,000 which never enters the calculation — it represents a book write-up, not cash.

The break-up value then adds appreciation in stock and intangible assets and reduction in payables (3.5L + 5L + 1.5L = INR 10,00,000) and subtracts depreciation in scrap value of fixed assets and receivables (72L + 6.25L = INR 78,25,000), giving a break-up value of INR 32,75,000, or INR 327.50 per share.

The replacement value takes book value of assets INR 2,00,00,000, adds appreciation in stock and intangibles INR 8,50,000 and additional setting up costs INR 20,00,000, deducts depreciation in fixed asset value on going concern basis INR 12,00,000, giving a replacement value (Enterprise Value) of INR 2,16,50,000.

Note what each produces: book value and break-up value give EQUITY value; replacement value gives ENTERPRISE value.

When to use it at all

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.

14.6 Discounted Cash Flow valuation, in four steps

The DCF methodology is based on finding the present value of the free cash flow of a company by discounting such cash flow at its weighted average cost of capital (WACC). The free cash flow is usually computed for a specified forecasting period of about 5 YEARS and thereafter a perpetual TERMINAL VALUE is added to it.

The sum of the present value of the forecasted free cash flow and the terminal value provides the present value of the company's business. From this consolidated value, the OUTSTANDING DEBT in the company is deducted to arrive at the EQUITY VALUE. This equity value when divided by the number of outstanding equity shares provides the value per share.

Step 1 — Free Cash Flow during the forecast period

OCF = PAT + Depreciation +/− Non-cash charges in the P&L Account +/− Changes in working capital

If there are re-investment requirements in fixed assets, these are netted out from OCF to arrive at Free Cash Flow from Operations.

Depreciation and amortisations are added back since they are non-cash items appearing in the P&L account. 'Changes in working capital' is either a deduction or an addition depending upon whether the net working capital has increased or decreased during the year. Capital commitments (capital expenditure) are the normal capital expenditure requirement on an on-going basis. Such on-going capex and working capital investments are required in any business and are known as REINVESTMENT REQUIREMENTS. These are subtracted along with debt repayments (if any on long term account) from the operating cash flow generated during the year to arrive at the free cash flow.

Step 2 — The Terminal Value

The terminal value of the free cash flow (FCF) after the forecasted period is the last leg for future cash flow determination. This is calculated to perpetuity to capture the value of the cash flow that accrues after the forecasted period. It is calculated by considering the FCF for the T+1 year if 'T' is the last year of the forecasted period.

Terminal Value of FCF = FCF(T+1) / (WACC − g)

wherein 'g' is the expected growth rate of PAT after the discrete period and 'WACC' is the weighted average cost of capital.

Step 3 — The cost of capital

The WACC is estimated by taking the individual POST-TAX cost of debt and the cost of equity separately and multiplying them in the ratio of debt to equity in the capital structure. The cost of debt is considered at the average carrying cost in the balance sheet or the marginal cost of borrowing whichever is appropriate.

The cost of equity is usually based on the Capital Asset Pricing Model (CAPM) but is adjusted to reflect the ILLIQUIDITY PREMIUM of alternative assets and further specific risk premium if any applicable to the given company. Accordingly, THE COST OF EQUITY OF AN UNLISTED COMPANY WILL BE HIGHER THAN THAT OF A COMPARABLE LISTED COMPANY.

Box 14.1 — computing WACC: Cost of long term debt capital of a company is 12.5% pre-tax. Assuming a tax rate of 30%, the post-tax cost of debt is 8.75% (i.e. 12.5 × (1−0.3)) — because of the tax shelter provided by the interest paid on the loan. With Cost of Equity determined at 17.5% and a Debt-Equity Ratio of 1.5:1, the debt percentage in the total capital structure is 1.5 / 2.5 = 60%. Hence equity = 40%. So cost of debt will be 8.75 × 60% = 5.25% and cost of equity would be 17.5 × 40% = 7%, and the WACC would be arrived at by adding the two components, i.e. 5.25% + 7% = 12.25%.

Step 4 — Getting to value per share

In the worked example the WACC is considered at 11.35% and the terminal growth rate has been assumed at 5%.

The guidance on that growth rate matters: normally terminal growth rates for consolidated industries are considered at 2-3% ABOVE THE INFLATION RATE. Therefore, if inflation is 3%, the growth rate could be about 5-6%. In high growth or sunrise industries which are expected to maintain significant growth for a long period of time, there is a justification to take higher terminal growth rates.

And a warning worth underlining:

The consideration of the terminal growth rate is very significant as it influences the value of shares almost all by itself in young companies. Since venture capital funds and private equity funds deal with young and growing unlisted companies, the terminal growth rate could be an important parameter for the investor to consider.

The Terminal Value (TV) is calculated as FCF of the last year (Year5 × (1+g) / (WACC−g)). This provides a value of INR 43062.54. This value is discounted at the factor applicable to the TV, i.e. the TVF of 0.5245 to arrive at the PV of the TV. The sum of the two values provides the Enterprise Value of the company, i.e. PV of FCF + PV of TV. The Enterprise Value is reduced by the amount of debt outstanding which is assumed above as INR 1324. After the deduction of outstanding debt, the resultant value provides the equity value of the business. Dividing this value by the number of outstanding equity shares provides the Value per share.

DCF gives ENTERPRISE value first. Subtract debt to get EQUITY value. Divide by shares to get value per share.

14.7 Relative or Multiple based Valuation

'Relative valuation' is an approach that believes that assets and firms have to be valued on the basis of their current market price. The methodology involves the use of certain standardised multiples that can derive value and enable inter firm comparison and value benchmarking.

The popularity of this approach stems from the fact that it is easier to explain and less quantitative than the DCF approach. Relative valuation is widely used by research analysts, transaction bankers, investors, brokers and other market participants.

The four disadvantages

(a) it does not take into account the future capital expenditure and incremental working capital requirements which could have a significant impact on value, (b) it is suitable only when companies have reached maturity and are quite stable in their future outlook, (c) the selection of multiples is subjective and (d) multiples are driven by external factors which could alter a company's valuation without there being any fundamental shift in its intrinsic value between two given points of time.

The two families of multiple

Relative valuation is based on multiples that are adopted from two different approaches — (1) 'Earnings based multiples' (also known as 'Transaction Comparables' or 'Deal Comps') and (2) 'Market based multiples' (also known as 'Trading Comps').

In the former category the most commonly used are the EV/EBITDA multiple and EV/Sales or EV/Revenue multiple (also known as 'topline multiple'). In the 'Trading comps' category, the most common are the Price-Earnings Multiple (P/E Ratio) and the Price-Book Value Multiple (P/BV Ratio).

The P/E ratio is the most widely used market related multiple in valuation. However, there are also those firms that are not listed and therefore lack a market price validation. Therefore, for unlisted companies, TRADING COMPS ARE QUITE UNSUITABLE and at best, current market multiples applicable to listed surrogates may be used to value unlisted companies.

And the point that ties back to section 14.4.1:

It may however be noted that, 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.

14.7.1 The EV/EBITDA multiple

EV / EBITDA = Value of Firm / EBITDA. Higher the above multiple, higher is the value of the company.

The advantage of using the EBITDA in the place of PAT is that EBITDA is a measure of OPERATIONAL EFFICIENCY. Therefore, higher the EBITDA, higher would be the return on investment (ROI) and hence the efficiency of the capital in business.

Secondly, 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.

Illustration 14.6: Enterprise Value of the Company = INR 26,737.79 lakh. If the estimated EBITDA for Y1 = INR 1875 lakh, EV to EBITDA multiple = 26737.79 / 1875 = 14.26.

14.7.2 The Price to Book Value multiple

EV / Networth = Value of Firm / Networth

The footnote defines it: Networth is defined as Net Fixed Assets + Long Term Investments + Net Current Assets − Long Term Liabilities. Alternatively, Networth = Shareholders' Funds, i.e. Share Capital + Accumulated Reserves.

Usually, in listed companies, if a company's market value is 4-5 times of its book value, it is considered a healthy valuation. In unlisted companies, the DCF value can be cross-checked with the book value multiple. However, in start-ups and other technology companies WHERE BOOK VALUE COULD BE NEGATIVE, THIS MULTIPLE CANNOT BE USED.

Illustration 14.7 explains how book value turns negative: at the time of financing, the company shows a positive net worth and book value of share based on the subscribed capital and the securities premium. Such companies take time to show profits since they may be using their cash mainly to develop products or market by incurring huge costs... As the company keeps making losses, the accumulated losses would wipe out the reserves and may even erode the nominal value of the subscribed capital. Thus, the book value of the share can become negative.

14.7.3 The Price to Earnings multiple

This multiple is used extensively in determining the market valuation of stocks in listed companies as the price used in this metric is the current market price of the share. It can also be used sometimes to compare unlisted companies in alternative space to their listed peers to know the range at which they are being valued.

Illustration 14.8: Alpha Ltd has an after tax profit of INR 100 lakhs and a paid up capital of INR 200 lakhs divided into 20 lakhs shares of INR 10 each. It currently trades at a P/E multiple of 32. Earnings Per Share (EPS) = 10,000,000 / 2,000,000 = INR 5. Current Market Price = 32 × 5 = INR 160 per share.

Other multiples

A few more variations that can be used in the multiple based valuation approach are the PAT multiple (Value of Firm / PAT) and the Earnings before interest and Tax (EBIT) multiple (Value of Firm / EBIT).

In early stage companies and certain other technology or service based companies, NON-FINANCIAL MULTIPLES may also be used. In e-commerce, the GMV multiple (gross merchandise value) is used. In telecom the ARPU (average revenue per user) is used. In the hotel industry, the ARR (average room revenue) is used sometimes.

Multiples approach is very useful to VALIDATE the valuation arrived at by a different approach as it can easily be compared against peer companies both in the listed and unlisted categories as well as to industry benchmarks.

Think of it like this

The mango tree, and three ways to price it

You are buying a mango orchard. What is it worth?

The income approach asks: how many mangoes will it yield each year, for how many years, and what is that stream worth today? That is DCF — the value of any financial investment is the Net Present Value (NPV) of its future cash flows. It is the theoretically right answer, and it is also the one most sensitive to your guesses about rainfall, prices and how long the trees live. Though the DCF appears to be a straight forward calculation, it is fraught with difficulty.

The relative approach asks: what did the orchard down the road sell for, per acre? Easy, quick, and only as good as the comparison. The use of relative valuation is tricky since it requires comparing "an apple to an apple".

The asset approach asks: what would the land, the trees and the tube well fetch if sold off? That is break-up value — the current market value of the company if it is broken up and sold in individual pieces of assets. Useful if the orchard is dying; almost meaningless if it is thriving.

The workbook sets the hierarchy plainly: the other methods are used more to CORROBORATE the fundamental value derived from cash flow based valuation. Cash flow answers the question. The rest check the answer.

Enterprise Value is the flat; Equity Value is your share of it

You buy a flat for INR 1 crore. You put in INR 30 lakh and borrow INR 70 lakh.

The flat is worth INR 1 crore. That is Enterprise Value — the debt-free/cash free value of the operating business... the value of the total capital in the company or business regardless of whether it is debt or equity capital. It does not care who funded it.

Your stake is worth INR 30 lakh. That is Equity Value — the total value of funds belonging to equity shareholders in the company after all other, including debt and preference capital, have been deducted.

Enterprise Value = Equity Value + Total Debt (net of cash) + Preference capital.

Now the practical consequence, and it is the single commonest error in this topic. 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. The same applies to DCF: the Enterprise Value is reduced by the amount of debt outstanding... the resultant value provides the equity value of the business.

So if someone tells you the EV/EBITDA multiple values the company at INR 1,245 crore, the shareholders do not own INR 1,245 crore. They own what is left after the lenders and preference holders are paid.

Why revaluation reserve never counts

Suppose you bought land for INR 1 crore in 2010. A valuer now says it is worth INR 5 crore, and your accountant creates a revaluation reserve of INR 4 crore on the balance sheet. Your net worth has jumped by INR 4 crore. Are you richer?

On paper, yes. In cash, nothing has happened. No one has bought anything from you.

Which is why the workbook, in computing book value in Illustration 14.4, carefully footnotes: cash networth does not include revaluation reserve. Hence it is excluded from valuation.

Look at what IS included: general reserve, capital redemption reserve, debenture redemption reserve, surplus in P&L account — every one of them representing profits actually earned and retained. And what is excluded: the one reserve created by an accounting opinion rather than by trading.

This is also why book value of share of a company is normally considered the "floor price" or the least value attributable to a "going concern" business. A floor built on real retained profits is a floor. A floor built on revaluations is a trapdoor.

The terminal value is most of the answer

In the workbook's DCF illustration, the forecast covers five years — and then a Terminal Value of INR 43,062.54 is computed for everything after that, discounted at a factor of 0.5245.

Do the arithmetic in your head: the terminal value alone contributes over INR 22,500 of present value, against an Enterprise Value of INR 26,737.79 lakh in the same example. In young companies the proportion is even more extreme.

The workbook says so directly: the consideration of the terminal growth rate is very significant as it influences the value of shares almost all by itself in young companies. Since venture capital funds and private equity funds deal with young and growing unlisted companies, the terminal growth rate could be an important parameter for the investor to consider.

And look at the formula: Terminal Value = FCF(T+1) / (WACC − g). As g approaches WACC, the denominator approaches zero and the value approaches infinity. Move g from 5 per cent to 8 per cent against a WACC of 11.35 per cent and the terminal value roughly doubles.

Which is why the discipline matters: normally terminal growth rates for consolidated industries are considered at 2-3% above the inflation rate. Therefore, if inflation is 3%, the growth rate could be about 5-6%.

When someone shows you a DCF, ask for g first.

Why an unlisted company's cost of equity is always higher

Two identical businesses, same margins, same growth. One is listed on the NSE; the other is private. Which has the higher cost of equity?

The private one — always.

The cost of equity is usually based on the Capital Asset Pricing Model (CAPM) but is adjusted to reflect the ILLIQUIDITY PREMIUM of alternative assets and further specific risk premium if any applicable to the given company. Accordingly, the cost of equity of an unlisted company will be higher than that of a comparable listed company.

Think about what you give up. In the listed company you can sell on Monday morning at a screen price. In the private one you may wait seven years for an exit that depends on a buyer appearing. That waiting has a price, and the price is a higher required return.

Now trace the consequence through the DCF. Higher cost of equity → higher WACC → a larger discount rate → lower present value → the same business is worth less when it is private.

The same logic reappears in the IPEV multiples method: it is normal to apply a discount to the quoted market ratio to reflect illiquidity discount applicable to unlisted stock. This discount may be reduced if a fund manager believes an exit to be imminent. Notice the second sentence — as the exit comes into view, the illiquidity shrinks, and so does the discount.

EBITDA for the company that has not made a profit yet

A three-year-old logistics company earns revenue of INR 400 crore and an EBITDA of INR 40 crore. After interest on its warehouse loans and depreciation on its fleet, its PAT is minus INR 15 crore.

Value it on a P/E multiple and you get a negative number. Value it on P/BV and, if accumulated losses have eaten the reserves, you may also get a negative number — in start-ups and other technology companies where book value could be negative, this multiple cannot be used.

Value it on EV/EBITDA and you get a sensible answer.

The advantage of using the EBITDA in the place of PAT is that EBITDA is a measure of operational efficiency. Therefore, higher the EBITDA, higher would be the return on investment (ROI) and hence the efficiency of the capital in business. Secondly, 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.

The insight generalises. Every multiple fails on some company. P/E fails on the loss-maker. P/BV fails on the asset-light company with eroded reserves. EV/EBITDA fails on the pre-revenue start-up — which is why the industry reaches for GMV in e-commerce, ARPU in telecom, average room revenue in hotels.

Pick the multiple that the business can actually answer.

Key terms in this chapter

Adjusted NAV: Fund NAV after deducting taxes and statutory payments, outstanding fees and expenses, carried interest and other contractual deductions — the cash investors would actually receive if all portfolio assets were realised on the valuation date.
AIPAC: The Alternative Investment Policy Advisory Committee of SEBI, whose recommendations an AIF industry association must consider before endorsing valuation guidelines.
Amortized cost: The purchase cost of a security adjusted for any discount or premium over its maturity period, plus accrued interest. Used for unlisted non-equity securities with no ascertainable market.
Book Value approach: Net asset value per share computed from balance sheet values at historical cost. Normally treated as the floor price for a going concern. Revaluation reserve is excluded from cash net worth.
Break-up Value approach: The salvage value if the business were shut down and sold in individual pieces on the valuation date. Used for a company in distress or without a future business case.
Churn Rate: The percentage of customers who discontinue using a product or service over a given period — a test of whether the investee company is in a sustainable business environment.
Class of units: Units carrying differential rights assigned by the manager based on commitment size, timing and proportion of corpus. All classes share the same underlying portfolio but may differ in fee structure, expense allocation and other rights.
Deal Comps vs Trading Comps: Earnings-based multiples such as EV/EBITDA and EV/Sales are transaction comparables or deal comps; market-based multiples such as P/E and P/BV are trading comps, which are quite unsuitable for unlisted companies.
Discounted Cash Flow (DCF): Valuing an asset as the net present value of its future cash flows, discounted at the weighted average cost of capital. Theoretically the most acceptable method, but extremely sensitive to the timing of cash flows and to assumptions.
Enterprise Value (EV): The debt-free, cash-free value of the operating business, measured against EBITDA and reflecting 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 per cent of the shares — the funds belonging to equity shareholders after debt and preference capital have been deducted. For a listed company this is market capitalisation.
EV/EBITDA multiple: Enterprise Value divided by EBITDA. Useful because EBITDA measures operational efficiency and remains positive in companies whose PAT is negative due to interest, depreciation and amortisation.
Fair Value: The arm's length price between a willing buyer and seller who are not connected. 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.
Free Cash Flow: Operating cash flow — PAT plus depreciation, adjusted for non-cash charges and changes in working capital — less reinvestment requirements such as ongoing capex and long-term debt repayments.
Illiquidity premium: The adjustment added to a CAPM-derived cost of equity for alternative assets, which is why the cost of equity of an unlisted company is always higher than that of a comparable listed company.
Illiquid security valuation: Illiquid securities may not be valued at fair market value. One accepted method discounts the future proceeds of selling the holding over the days its trading volume would require, at the fund's opportunity cost of capital.
Independent valuer eligibility: Not an associate of the manager, sponsor or trustee; at least 3 years' experience valuing unlisted securities; and either IBBI registration with ICAI, ICSI, ICMAI or CFA Institute membership, or being a holding company or subsidiary of a SEBI-registered credit rating agency.
IPEV Guidelines: International Private Equity and Venture Capital Valuation Guidelines, providing principles-based valuation guidance for Category I and II AIFs, centred on fair value and endorsed by the Indian AIF Industry Association.
Leverage (Category III): Total exposure of long plus short positions after permitted offsetting, divided by NAV, capped at 2 times NAV with prior investor consent. Idle cash and commitment-covered temporary borrowings are excluded from exposure.
Mark-to-Market: Valuing the portfolio at fair market value on every Valuation Day. Without it the portfolio would remain at cost. It underpins fair incentive fee computation, redemption pricing, and daily margin reconciliation.
Net Promoter Score (NPS): The percentage of promoters (customers answering 9 or 10) minus the percentage of detractors (answering 6 or lower). Those answering 7 or 8 count for neither.
Non-financial multiples: Industry proxies used where cash-based metrics fail — GMV (gross merchandise value) in e-commerce, ARPU (average revenue per user) in telecom, and average room revenue in hotels.
Offsetting positions: Long positions (long futures and call options) may be netted against short positions (short futures and put options) only where they are on the same stock, index or commodity with the same maturity period.
Option Pricing Method (OPM): A forward-looking early-stage valuation method that takes current equity value and allocates it across classes of equity assuming a continuous distribution of outcomes rather than distinct scenarios.
Post-money valuation: Pre-money valuation plus the new investment. A fixed cheque buys a larger stake on a post-money basis than the same headline number quoted pre-money.
Pre-money valuation: The estimated value of a start-up immediately before it receives external funding, based on existing assets, IPR, market size and team expertise.
Present Value Annuity Factor (PVA): PVA(n,r) = (1 − (1 + r)^−n) / r, used to discount a stream of equal payments such as bond coupons. The single-sum PV factor is 1/(1+r)^n.
Price of previous transaction method: An IPEV method under which a follow-on investment price becomes the implied market value applied to the whole holding. A first investment is carried at cost until a follow-on round reprices it.
Price to Book Value multiple: Value of firm divided by net worth. A market value 4 to 5 times book value is considered healthy in listed companies, but the multiple cannot be used where accumulated losses have made book value negative.
Priority distribution model: A structure in which one class of investors receives a higher share of profits at the cost of another class. No Category III AIF may adopt it.
Relative valuation: Valuing a firm using standardised multiples against comparable companies or transactions. Easier to explain than DCF, but ignores future capex and working capital, suits only mature companies, and depends on subjective multiple selection.
Replacement Cost approach: Valuing the business at the cost of replacing it as-is-where-is, including the costs of establishing it as a going concern. Appropriate for businesses with high entry barriers or setting-up costs; it produces an Enterprise Value.
Series NAV: Series Assets less Series Liabilities and Series Expenses, divided by the units in that series and rounded to four decimal places. Series Assets = Total Assets × Opening Series NAV / Total of all Opening Series NAV.
Sum of parts / bottom-up approach: Fund NAV computed as the sum of the fair values of underlying portfolio investments, added from the bottom up as at the valuation date.
Terminal growth rate (g): The expected growth rate of PAT after the forecast period. Normally set 2 to 3 per cent above the inflation rate for consolidated industries, with higher rates justifiable for sunrise industries.
Terminal Value: The perpetuity value of cash flows beyond the forecast period, computed as FCF(T+1) / (WACC − g). In young companies it can drive the valuation almost by itself.
Valuation Day: The pre-determined day by reference to which a Category III AIF's NAV is computed — at least monthly for open-ended and quarterly for closed-ended funds, daily where the fund invests in listed securities only, and on any day fixed for a closing, redemption or distribution.
Valuation deviation thresholds: A deviation of more than 20 per cent between two consecutive valuations of an asset, or more than 33 per cent in a financial year, must be reported to investors with reasons.
Viral Coefficient: A measure of exponential growth from referrals per user, the conversion rate of those referrals and the number of current users — for example three referrals each converting at 33 per cent means three users generate one new paid user.
Volume Weighted Average Yield (VWAY): The basis for valuing debt. T-bills and G-Secs use VWAY of trades in the last one hour of trading; all other money market and debt securities use VWAY of all trades during the day.
WACC: The weighted average of the post-tax cost of debt and the cost of equity in the ratio of debt to equity in the capital structure. Used as the DCF discount rate.

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

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