DCF Valuation for M&A Due Diligence
Build discounted cash flow models for target company valuation in M&A contexts.
Unit System (Critical)
- Storage: Absolute dollars (raw financial data)
- Calculation: Millions (DCF models expect this)
- Display: Smart formatting (B/M/K based on magnitude)
- Never pass raw stored values directly into DCF calculations without unit conversion
Validation Before Calculation
- Verify base revenue exists and is non-zero
- Confirm WACC is between 5-25% (flag outliers with explanation)
- Terminal growth must be less than WACC (Gordon Growth Model constraint)
- Projection period: 5-10 years (default 5)
- Verify EBITDA margins are within plausible industry range
Default Assumptions
| Parameter | Default | Rationale |
|---|
| ----------- | --------- | ----------- |
| Tax rate | 21% (US) / 17% (SG) | Adjust per jurisdiction |
| CapEx as % of revenue | 5% | Adjust per industry (SaaS ~3%, manufacturing ~8-12%) |
| Terminal growth | 2.5% | Should not exceed long-term GDP growth |
| WACC | CAPM-calculated | Fallback: 10-12% for mid-market |
| Depreciation | % of CapEx | Match to industry capital intensity |
| Working capital change | % of revenue delta | Use historical average if available |
WACC Calculation (CAPM)
Cost of Equity = Risk-Free Rate + Beta × Equity Risk Premium
WACC = (E/V × Cost of Equity) + (D/V × Cost of Debt × (1 - Tax Rate))
- Risk-free rate: 10-year Treasury yield
- Equity risk premium: 5-7% (Damodaran)
- Beta: Use comparable public companies, unlever/relever for target capital structure
- Size premium: Add 2-4% for small/mid-market targets
Projection Methodology
- Revenue: Start from last reported, apply growth rates (declining toward terminal)
- EBITDA: Apply margin assumptions (converge toward industry median)
- Free Cash Flow: EBITDA - Taxes - CapEx - Change in Working Capital
- Terminal Value: Gordon Growth Model or Exit Multiple method
- Discount: Apply WACC to each year's FCF + terminal value
Terminal Value
Prefer Exit Multiple method for M&A (matches how buyers think):
- Apply EV/EBITDA multiple to terminal year EBITDA
- Cross-check with Gordon Growth implied multiple
- Flag if implied perpetuity growth exceeds 3%
Required Output
Always present:
- Enterprise Value range (low / base / high)
- Equity Value (EV - net debt)
- Implied EV/EBITDA multiple (sanity check against comparables)
- Sensitivity table: WACC (rows) vs Terminal Growth or Exit Multiple (columns)
- Football field chart if multiple valuation methods available
M&A-Specific Considerations
- Apply a control premium (20-40%) if valuing for acquisition vs. minority stake
- Consider synergy value separately from standalone DCF
- Discount rate should reflect buyer's cost of capital, not target's
- Model integration costs as a deduction from synergy value
- Present with-synergies and without-synergies valuations separately