Core concepts

01Funding stages: bootstrapping → angel → seed → Series A/B/C → IPO/exit.
02Valuation methods: DCF (FCFF/FCFE), relative valuation, asset-based, real options.
03Pre-money & post-money valuation differ by investment amount.
04Convertible instruments: SAFE, CCD, optionally convertible debenture.
05Exit options: IPO, strategic sale, secondary, buy-back.

Flowchart summary

Exam-critical pointers

⭐DCF unsuitable for early-stage startups (no stable cash flows) — use scorecard / VC method.
⭐Down-round protections: anti-dilution (broad-based weighted average is common in India).
⭐DPIIT recognised startups — Sec 80-IAC tax holiday (3 of 10 consecutive years).
⭐SEBI ICDR allows IPO with profitability OR alternative compliance route.

Explained simply

Imagine you have a lemonade stand dream. You start with pocket money — that's bootstrapping. You're building your stand with your own coins! 🍋

Why does this matter? As your stand gets bigger, you need more money. Friends, then strangers, then big investors help you grow. But each helper wants to own a piece of your stand. Understanding how much your stand is worth keeps everyone happy.

Here's the story. Day one: You spend 100 rupees of your own money. Day five: A rich uncle says "I'll give you 200 rupees if you give me half your stand." Now your stand is worth 400 rupees total — that's post-money value. Pre-money was 200, investment was 200. Uncle owns half because 200 divided by 400 equals one-half. 📊

Later, your stand makes real money. You sell juice, not just dreams. Now fancy accountants use big-kid math called DCF — they guess your juice money in five years, then work backwards. But when you're tiny and new, this doesn't work. Instead, we count your idea points: Do you have a good team? Smart idea? Big dream? This scorecard tells the true value better.

One CA thing: When grown-up companies go public (IPO), investors want proof of profit. New startups get a special pass — they can skip the profit rule if they follow other safety rules. This helps Indian startups grow big and hire more people.

Elaborative notes

Business Valuation

Valuation is AFM's most computationally intensive chapter. It tests whether

the student can move fluidly between **FCFF, FCFE, dividend discount,

relative valuation, and the terminal-value plug** that often determines

80% of enterprise value.

1. The four approaches

Approach	Discount rate	Use when
FCFF (Free Cash Flow to Firm)	WACC	Capital structure is changing; debt is significant
FCFE (Free Cash Flow to Equity)	Cost of Equity (K_e)	Mature, stable leverage; you want direct equity value
Dividend Discount (DDM / Gordon)	K_e	Stable, dividend-paying firms
Relative valuation (P/E, EV/EBITDA, P/B)	— (multiples)	Comparable listed peers; sanity-check absolute models

2. WACC — the universal discount rate for FCFF

WACC = (E/V) × K_e + (D/V) × K_d × (1 − t)

•E/V and D/V at market values, not book.
•K_d × (1 − t) reflects the tax shield on interest — only post-tax.
•K_e usually from CAPM: K_e = R_f + β × MRP.

3. FCFF computation — the standard ladder

Start from EBIT (operating profit):

Step	Item	₹ Cr
1	EBIT	given
2	× (1 − t)	tax-adjusted operating profit
3	+ Depreciation & amortisation	non-cash add-back
4	− Capex	cash outflow
5	− ΔWorking capital	tied-up cash
=	FCFF	result

FCFE = FCFF − Interest × (1 − t) + Net debt raised

(or directly: PAT + Depreciation − Capex − ΔWC + Net debt raised)

4. Two-stage DCF — explicit forecast + terminal value

Forecast FCFF for 5–10 explicit years.
Compute terminal value at horizon: TV = FCFF_{n+1} / (WACC − g) (Gordon

growth, perpetuity). Use a sustainable g, typically GDP growth (5–6%).

Enterprise Value = Σ (FCFF_t / (1 + WACC)^t) + TV / (1 + WACC)^n
Equity Value = EV − Debt + Cash
Per-share value = Equity Value / Diluted shares

TV often = 70–80% of EV. Sensitivity of g and WACC matters more than the

explicit-forecast FCFFs. Examiners reward students who flag this.

5. Dividend Discount Model variants

5.1 Constant growth (Gordon)

P_0 = D_1 / (K_e − g)

where D_1 = D_0 × (1 + g).

5.2 Multi-stage

•High growth for n years (compute each D_t, discount).
•Stable growth thereafter (compute TV at year n via Gordon, discount back).

5.3 H-model (semi-rare in ICAI)

Linear taper from high g to stable g over 2H years. Formula:

P_0 = [D_0 × (1 + g_n) + D_0 × H × (g_s − g_n)] / (K_e − g_n)

6. Relative valuation

•P/E: Price / EPS. Compare to peer-group mean / sector mean. Adjust for

growth (PEG = P/E ÷ growth%).

•EV/EBITDA: Use when capital structure varies across peers — neutralises

D/E differences.

•P/B: For banks, NBFCs, asset-heavy businesses.

When ICAI asks "value Sunrise Pharma" with both projected financials and

peer multiples, the topper convention is to compute both — DCF for the primary

estimate, multiples as a cross-check, then state a range: "₹X to ₹Y per share

with central estimate ₹Z."

7. ICAI exam patterns

Attempt	Question shape	Marks
May 2025	FCFF + WACC + TV + EV → per share	8
Nov 2024	DDM multi-stage + P/E sanity check	8
May 2024	FCFE vs FCFF reconciliation	6
Nov 2023	Two-stage DCF with terminal	8
May 2023	Relative valuation peer set	6
Nov 2022	DDM constant growth + cost of equity	5
May 2022	FCFF with mid-year discounting	6
Nov 2021	EV/EBITDA range	4
Jul 2021	DCF with sensitivity to g	8
Nov 2020	Pre-money / post-money valuation (VC)	4

Frequency: business valuation appears in 9 of last 10 attempts. Expected

weight in May 2026: 8 marks (one full Q2 part).

8. The 60+ marks topper convention

•Show WACC computation as a 3-line block before the FCFF table —

examiners look for this.

•Build the FCFF table with one row per year and a clear "Σ PV =" line.
•Show TV explicitly in a separate line: "TV at year 5 = FCFF_6 / (WACC −

g) = ..."

•Bridge EV to equity: "EV − Debt + Cash = Equity Value = ..."
•Box the per-share value.
•State the assumption note: "Mid-year discounting / end-year discounting

used; growth g taken as 4% per management guidance" — earns presentation

marks.

Worked examples

Worked example — DCF valuation of Sunrise Pharma Ltd.

Year	EBIT (₹ Cr)	Dep (₹ Cr)	Capex (₹ Cr)	ΔWC (₹ Cr)
1	240	60	90	25
2	280	70	100	30
3	320	80	110	35
4	360	90	115	40
5	400	100	120	45

t = 25%, K_e = 14%, K_d(post-tax) = 7%, D:E = 30:70, g_terminal = 4%,

Debt = ₹600 Cr, Cash = ₹120 Cr, Shares = 10 Cr.

Step 1 — WACC

WACC = 0.7 × 14% + 0.3 × 7% = 9.8% + 2.1% = **11.9%**

Step 2 — FCFF for each year

FCFF_t = EBIT_t × (1 − t) + Dep_t − Capex_t − ΔWC_t

Year	EBIT(1−t)	Dep	Capex	ΔWC	FCFF
1	180	60	90	25	125
2	210	70	100	30	150
3	240	80	110	35	175
4	270	90	115	40	205
5	300	100	120	45	235

Step 3 — Terminal Value at year 5

FCFF_6 = 235 × (1 + 0.04) = 244.4

TV_5 = 244.4 / (0.119 − 0.04) = 244.4 / 0.079 = **₹3,094 Cr**

Step 4 — Present value of FCFFs + TV

Discount factor at WACC = 11.9%.

Year	FCFF	DF	PV
1	125	0.8937	111.7
2	150	0.7986	119.8
3	175	0.7137	124.9
4	205	0.6378	130.7
5	235	0.5700	134.0
5 (TV)	3,094	0.5700	1,763.6

Enterprise Value = 111.7 + 119.8 + 124.9 + 130.7 + 134.0 + 1,763.6 = **₹2,384.7 Cr**

Step 5 — Equity Value & per-share

Equity Value = EV − Debt + Cash = 2,384.7 − 600 + 120 = **₹1,904.7 Cr**

Per-share value = 1,904.7 / 10 = **₹190.47**

Assumption note

•End-of-year discounting used (standard ICAI convention).
•Terminal growth g = 4% (in line with GDP growth, conservative).
•WACC computed at target capital structure (30:70 D:E at market values).

Detailed flowcharts

Business Valuation — Approach Selector

Render diagram ↗

flowchart TD
  A[Need to value<br/>a business] --> B{Capital structure<br/>changing?}
  B -->|Yes| C[FCFF approach<br/>discount by WACC]
  B -->|No, stable| D{Pays<br/>dividends?}
  D -->|Yes & stable| E[DDM — Gordon]
  D -->|No / not steady| F[FCFE approach<br/>discount by K_e]

  C --> G[Compute FCFF:<br/>EBIT·1−t + Dep<br/>− Capex − ΔWC]
  G --> H[Forecast 5 yrs]
  H --> I[Terminal value<br/>TV = FCFF_6 / WACC−g]
  I --> J[EV = Σ PV·FCFF<br/>+ PV·TV]
  J --> K[Equity Value =<br/>EV − Debt + Cash]
  K --> L[Per share =<br/>Equity / Diluted shares]

  E --> M["P₀ = D₁ / K_e − g"]
  F --> N[FCFE = PAT + Dep<br/>− Capex − ΔWC<br/>+ Net debt raised]
  N --> O[Discount at K_e<br/>directly to<br/>Equity Value]

  L --> P[Cross-check with<br/>P/E and EV/EBITDA<br/>peer multiples]
  M --> P
  O --> P
  P --> Q[Report range:<br/>₹X to ₹Y<br/>central ₹Z]

  style C fill:#dbeafe,stroke:#1d4ed8
  style E fill:#dcfce7,stroke:#15803d
  style F fill:#fef3c7,stroke:#b45309
  style Q fill:#f3e8ff,stroke:#7c3aed

WACC Build — Watch the Traps

Render diagram ↗

flowchart LR
  A[WACC inputs] --> B[Cost of Equity K_e]
  A --> C[Cost of Debt K_d]
  A --> D[Capital structure weights]

  B --> B1["K_e = R_f + β · MRP<br/>CAPM"]
  B1 --> B2[R_f from 10-yr G-Sec]
  B1 --> B3[MRP from country premium<br/>or historical]

  C --> C1["Pre-tax K_d<br/>from current<br/>cost of debt"]
  C1 --> C2["× 1 − t<br/>tax shield"]
  C2 --> C3[Post-tax K_d]

  D --> D1{Book or<br/>market<br/>weights?}
  D1 -->|Book| D2["❌ WRONG<br/>understates equity"]
  D1 -->|Market| D3["✓ Correct"]

  B2 --> E[Combine]
  C3 --> E
  D3 --> E
  E --> F["WACC = E/V · K_e<br/>+ D/V · K_d · 1−t"]

  style D2 fill:#fee2e2,stroke:#dc2626
  style D3 fill:#dcfce7,stroke:#15803d
  style F fill:#dbeafe,stroke:#1d4ed8

Pitfalls examiners flag

Common pitfalls

Using book weights for WACC. Standard error — use market values for

D/V and E/V.

Forgetting the tax shield on debt. K_d in WACC must be after-tax:

K_d × (1 − t). Pre-tax K_d overstates WACC.

Discounting TV one period too many. TV computed at year n is already

the year-n value — discount by (1 + WACC)^n, not (n + 1).

Mixing nominal and real rates. If FCFF projections are nominal, WACC

and g must be nominal. Don't blend.

Setting g > WACC. Mathematically the perpetuity diverges. ICAI sometimes

plants this as a trap — students mechanically apply Gordon without checking.

Confusing FCFF and FCFE. FCFF is firm-level (discount by WACC to get

EV); FCFE is equity-only (discount by K_e to get equity value directly).

Mismatching denominator and numerator double-counts debt.

Forgetting cash and non-operating assets in the EV → equity bridge.

Equity Value = EV − Debt + Cash + Non-op assets. Many answers omit cash.

30-second revision card

Business Valuation — 30-second recap

•FCFF discounted by WACC, FCFE by K_e, DDM by K_e
•FCFF = EBIT(1−t) + Dep − Capex − ΔWC
•WACC = (E/V)·K_e + (D/V)·K_d·(1−t) — market-value weights
•TV = FCFF_{n+1} / (WACC − g), often 70–80% of EV
•Equity Value = EV − Debt + Cash
•Cross-check with P/E and EV/EBITDA — state a range
•Always state assumption note; always box per-share value

Make it click