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If you have a preferred company, think about why that is. If you really feel strongly about working for them, it may not make sense to risk losing the offer by bringing up the other offer. Just say you were expecting more and try to negotiate upward. But if you say you have a better offer they may take that as being unserious and rescind the offer.
Talk about how you are very excited about this opportunity. Then you have an offer with higher compensation of whatever amount, and you want to know if you can find some common ground or be more in line with that. Outside of all that, make sure you understand what the typical numbers are.
I would just tell them that you have had another offer, but would love to be part of there company, and ask if they can match what was offered. Worst they can say is no, but that does not mean they do not still want you. You will just have to decide at that point which company is better for you mentally or otherwise. Sometimes, a little extra money is not worth your happiness.
I'm not sure I would mention it for the reason Analyst stated. I think you should just try to negotiate for higher pay without bringing up the other offer. Most companies expect candidates to do this, and I doubt they'd hold it against you, whereas they might if you bring up the other offer.
There may be other benefits that, in the end, equal out to the same as the pay the other company is offering.