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## Example of a Discounted Cash Flow (DCF Calculation)

Here is an example of a discounted cash flow calculation for the sale of the hypothetical company (ABC Corporation): (The sample DCF calculations are available in Excel)

Current Year | Historic Growth Rate | Year One | |

Sales | 10,000,000 | 10% | 11,000,000 |

COGS | 4,000,000 | 10% | 4,400,000 |

Gross Margin | 6,000,000 | 6,600,000 | |

Expenses | |||

G&A | 1,000,000 | 7% | 1,070,000 |

Net Profit | 5,000,000 | 5,530,000 |

In this hypothetical, highly simplified example, we are assuming that all expenses are current expenses (no depreciation, amortization, or other non-cash expenditures). First ABC forecast based on their historic growth rate for the last several years of 10% in Sales and COGS. and 7% growth rate in G&A to get this for the next year. We also adjust the COGS number down by 10% because the acquiring company is far larger and can buy raw materials in bulk, saving 10%. We adjust G&A down by $500,000 because merging the two companies means that after the acquisition one CEO will step down and not be replaced and there will be savings from consolidating functions like payroll, billing, and information technology.

Since the company being acquired has developed new technology which it is just now introducing, we can forecast an increase in sales of 15% over baseline growth in year one and 10% in year two.

This gives us projected cash flows of:

Year 1 | 6,990,000 |

Year 2 | 8,446,200 |

### Adjustments

We have made the following adjustments to the financial statement for the first year after acquisition in our example:

- Increased Sales by 1,500,000 because new technology will allow the company to introduce a new product
- Decreased cost of goods sold by 400,000 because the bulk purchasing power of the acquirer will lower raw material cost.
- Increase COGS by 540,000 to account for the projected increase in sales
- Decrease G&A expenses by 100,000 to account for synergies.

These projections give us future financial statements that look like this:

Adjusted Year One Income | Growth to year 2 | Year 2 | |

Sales | 12,500,000 | 20% | 15,000,000 |

COGS | 4,540,000 | 20% | ,448,000 |

Gross Margin | 7,960,000 | 9,552,000 | |

Expenses | |||

G&A | 970,000 | 14% | 1,105,800 |

Net Profit | 6,990,000 | 8,446,200 |

We have come up with a discount rate of 30%, based on a risk free rate of 3% and a risk premium of 27%. So, the present value is:

$6,990,000/(1+0.3) + 8,446,200/(1+0.3)^{2} + (9,000,000/.3)/(1+0.3-.1)^{3}

which works out to:

5,376,923 + 4,997,751 + 18,386,377 = 28,761,051

So in our example the present value of ABC is $28,761,051 to this specific buyer.

Valuing a Company using Discounted Cash Flow DCF

Next, Capitalized Earnings Approach