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

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):

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

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

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

1. Enterprise Value = Σ (FCFF_t / (1 + WACC)^t) + TV / (1 + WACC)^n
2. Equity Value = EV − Debt + Cash
3. 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

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.