Our Own Estimates

Of course, we would like to project the income statement more than three years out. Since Wall Street equity research analysts typically project just one to three years of financial results for public companies, we must make our own assumptions to forecast the P&L further into the future. We often “flatline” our assumptions, meaning that we use margins and growth rates from the most recent year for which data is available (2010, in our case), and carry them forward.

We should point out one assumption we made regarding BuyerCo’s 2011 and 2012 capex. Had we flatlined capex using 2010’s capex as a percent of sales (e.g. 5.9%), we wouldn’t see much convergence of capex with depreciation expense by the end of the projection period. So, we chose some lower percentages for these years that provide for better convergence. Additionally, we could have used our own capex estimates for 2008 through 2010 rather than Deutsche’s figures to show even greater convergence.

We also added a column that calculates the compound annual growth rates (“CAGRs”) for various line items on the income statement over the projection period. Don’t get carried away with applying CAGRs–they are immaterial for such line items as SG&A and amortization expenses, for example. In general, only show CAGRs for revenue and other line items that would be computed as percent margins, rather than percent of sales.

Amortization expense is not normally projected forward as a percent of revenue, as is depreciation, but rather carried forward at its dollar value from the year prior.