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Advanced Financial Management · Business Valuation

Other Valuation Models and Special Cases for CA Final AFM

Updated 5 October 2026 · Fact-checked

These models value a business when plain DCF or asset values do not fit. The dividend discount model values equity as the present value of dividends; Gordon growth gives P0 = D1 ÷ (ke − g). Tobin's Q compares market value with replacement cost. Start-ups and brands use revenue multiples, scorecards or relief-from-royalty. Identify the model, pick inputs, compute, then interpret.

Understand Other Valuation Models and Special Cases

Not every business can be valued by a neat free cash flow forecast. Some pay steady dividends. Some have no profits yet. Some hold value mainly in a brand. This topic gives you tools for these cases.

The dividend discount model (DDM) says a share is worth the present value of all future dividends, discounted at the cost of equity (ke). If dividends grow at a constant rate g forever, the sum simplifies to the Gordon growth model. It works only when ke > g. It is best for stable, dividend-paying firms.

Growth does not come free. Under the value-driver approach, g = retention ratio (b) × ROE. If a firm reinvests more, g rises, but dividends fall. Extra retention adds value only when ROE is above ke. If ROE = ke, growth does not change value. If ROE < ke, retention destroys value.

Tobin's Q = market value of the firm ÷ replacement cost of its assets. Q above 1 suggests the market values the firm above the cost of rebuilding its assets. This may reflect strong intangibles or growth, or it may reflect overpricing. Q below 1 suggests undervaluation or poor use of assets. It is a signal, not a price.

Start-ups have little history, negative cash flows and high uncertainty. You use methods such as revenue or user multiples of comparable firms, a venture-capital method (exit value discounted at a high target return), scorecard or risk-factor adjustments, and scenario-weighted DCF. Brands and intangibles are valued by cost, market, or income methods. The common income method is relief-from-royalty: the present value of royalties saved by owning the brand, after tax.

Key rules to remember

Dividend discount model (general)
P0 = Σ Dt ÷ (1 + ke)^t + Pn ÷ (1 + ke)^n
Use for a finite holding period with a terminal price Pn.
Gordon growth model
P0 = D1 ÷ (ke − g) = D0 × (1 + g) ÷ (ke − g)
Valid only when g is constant forever and ke > g. Use D1, the next dividend.
Implied cost of equity
ke = D1 ÷ P0 + g
Rearranged Gordon model.
Sustainable growth
g = b × ROE, where b = 1 − payout ratio
ROE is the return earned on equity, and the new investment from retained earnings is assumed to earn this return.
Value with value drivers
P0 = E1 × (1 − b) ÷ (ke − b × ROE)
E1 is next year's EPS. If ROE = ke, P0 = E1 ÷ ke.
Two-stage DDM
P0 = Σ D_t ÷ (1+ke)^t (high growth years) + [D_(n+1) ÷ (ke − g_s)] ÷ (1+ke)^n
g_s is the stable growth rate after year n.
Tobin's Q
Q = Market value of firm ÷ Replacement cost of assets
Q > 1 may reflect intangibles or growth, or overpricing; Q < 1 may signal undervaluation.
Relief-from-royalty brand value
Brand value = Σ [Sales × royalty rate × (1 − tax rate)] ÷ (1 + r)^t + PV of terminal value
Discount at a rate reflecting brand risk.
Venture capital method
Post-money value today = Exit value ÷ (1 + target return)^n
Investor stake = investment ÷ post-money value.

How to solve Other Valuation Models and Special Cases questions

Use this order for any question on these models. It keeps your working clean and shows the examiner your logic.

  1. 1Read what is asked: value per share, firm value, implied ke or g, or a judgement on Q.
  2. 2Pick the model: constant dividends or growth means Gordon; changing growth means two-stage; no profits means start-up method; brand means royalty or cost method.
  3. 3List inputs and check the dividend timing: is the given dividend D0 or D1? Convert if needed.
  4. 4Find g from b × ROE if the question gives retention and ROE instead of g.
  5. 5Check ke > g. If not, say the model fails.
  6. 6Compute step by step. For multi-stage, value each year's dividend, then the terminal value, then discount it.
  7. 7Interpret: compare value with market price (undervalued or overvalued), or Q with 1.
  8. 8State the answer with units and one line of assumptions or limits.

Quickest way: Gordon first, then adjust

When to use it: Use when dividends are stable or growth is constant, and for any ke, g or P0 question with limited time.

  1. Write D1. If D0 is given, multiply by (1 + g).
  2. Get g. If not given, compute b × ROE.
  3. Apply P0 = D1 ÷ (ke − g) directly.
  4. For two-stage, compute only the explicit years in a small table and add one terminal value.
  5. Compare with market price in one line and conclude.

Common mistakes in Other Valuation Models and Special Cases

  • Using D0 instead of D1 in the Gordon formula

    The question gives the dividend just paid and students plug it straight in.

    Fix: Read the wording. 'Just paid' or 'recently paid' means D0, so multiply by (1 + g).

  • Applying Gordon when g ≥ ke

    Students apply the formula mechanically.

    Fix: Check ke > g first. If not, use a multi-stage model with a lower stable growth.

  • Using payout ratio as b in g = b × ROE

    The terms payout and retention are confused.

    Fix: b = 1 − payout ratio. Retention drives growth.

  • Discounting the terminal value at the wrong year

    In two-stage models the terminal value is computed at year n but discounted by n+1 years.

    Fix: The value at the end of year n using D(n+1) is discounted by (1 + ke)^n.

  • Calling every Q above 1 'overvalued'

    Students memorise a one-line rule.

    Fix: Say Q above 1 may reflect intangibles and growth or overpricing, and add context.

  • Ignoring tax in the relief-from-royalty method

    Royalty looks like a pre-tax saving and tax is forgotten.

    Fix: Multiply royalty by (1 − tax rate) before discounting.

Worked examples

Example 1

A company has just paid a dividend of ₹4 per share. Earnings per share were ₹10. ROE is 15% and the payout ratio is held constant. The cost of equity is 12%. Using the value-driver approach, find g and the intrinsic price per share. The share trades at ₹90. Is it undervalued?

Show the solution
  1. Payout ratio = 4 ÷ 10 = 40%, so b = 60%.
  2. g = b × ROE = 0.60 × 15% = 9%.
  3. D1 = 4 × 1.09 = ₹4.36.
  4. Check ke > g: 12% > 9%, so Gordon applies.
  5. P0 = 4.36 ÷ (0.12 − 0.09) = 4.36 ÷ 0.03 = ₹145.33.
  6. Market price ₹90 is below ₹145.33.

Answer: g = 9%; intrinsic value is about ₹145.33 per share. The share looks undervalued at ₹90, subject to the assumption that 9% growth lasts forever.

Example 2

A firm expects dividends of ₹2 in year 1 and ₹3 in year 2. From year 3 dividends grow at 5% forever. The cost of equity is 15%. Find the value per share. Use discount factors at 15%: year 1 = 0.8696, year 2 = 0.7561.

Show the solution
  1. D3 = 3 × 1.05 = ₹3.15.
  2. Price at end of year 2 = 3.15 ÷ (0.15 − 0.05) = ₹31.50.
  3. PV of D1 = 2 × 0.8696 = ₹1.7392.
  4. PV of D2 = 3 × 0.7561 = ₹2.2683.
  5. PV of terminal price = 31.50 × 0.7561 = ₹23.8172.
  6. Total = 1.7392 + 2.2683 + 23.8172 = ₹27.8247.

Answer: Value per share is about ₹27.82.

Exam tips

  • Always check whether the dividend given is D0 or D1 before substituting. Examiners set this trap often.
  • In case-scenario MCQs, a quick check of ke > g and g = b × ROE settles most options.
  • For start-up or brand questions, name the method and state two assumptions. Written answers earn marks for method as well as number.
  • Interpret every result in one line, such as undervalued, overvalued, or Q signal. Numbers without a conclusion lose marks.
  • Show terminal value and its discount year separately in multi-stage problems so partial marks are safe.

Practice questions from Business Valuation

Other Valuation Models and Special Cases in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Other Valuation Models and Special Cases: frequently asked questions

What is the difference between DDM and the Gordon growth model?

DDM is the general idea that value is the present value of all future dividends. Gordon growth is the special case where dividends grow at a constant rate forever. It reduces to P0 = D1 ÷ (ke − g).

What does Tobin's Q tell you?

It compares the market value of a firm with the replacement cost of its assets. A Q above 1 suggests the market sees value beyond physical assets, such as intangibles or growth, or the firm may be overpriced. A Q below 1 suggests the firm may be undervalued or using assets poorly.

How do I value a start-up in the CA Final exam?

Choose a method that suits the data given. Usually this is a venture-capital method using exit value and target return, or a multiple of comparable firms. State assumptions on risk and survival, and show the calculation of stake or value.

When does higher retention increase share value?

Only when ROE exceeds the cost of equity. Then reinvested funds earn more than shareholders require. If ROE equals ke, value is unchanged, and if ROE is lower than ke, retention reduces value.