Brown-Forman Distillers Corporation

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Question 1
As a leading producer, marketer and importer of wines and distilled spirits, Brown-Forman was the fifth-largest distiller in the United States. But the company spent huge amount of money advertising premium brands and significantly less on low profit brands. In the late 1970’s, the whiskey market declined and this presented Brown Foreman with growth challenges in a mature market. Brown-Foreman’s response to market pressures and competition was to aggressively move into other faster growing segments of the alcohol beverage market which required it to expand its product lines. The company also intended to increase its advertising spend to $86 million to aggressively promote its alcoholic product lines. The company also realized that future growth was very dependent on it gaining access to foreign markets. This case supports the view that Southern Comfort is an attractive horizontal acquisition for Brown-Foreman with the following pros and cons. PROS

20% of the Southern Comfort sales were overseas. Its exports market also had the highest 5 year compound growth rate than its other markets The company developed a distinctive brand with loyal customers Southern Comfort being a liqueur does not need to age and can be produced and sold much faster than the traditional whiskey line. Southern Comfort is a profitable company with a profit/sales ratio as high as 7% on par with Brown-Foreman. With an acquisition, shareholders value will lead to an increase in both earning per shares and the share value. Southern Comfort has a higher than average sales/assets ratio of 2.49 in 1977. It means the company has more profitable assets that can generate more earnings by minimizing the fixed cost per unit as a result of higher production levels. . CONS

Southern Comfort is not listed, the Brown Forman wants $94.6m for the company but the book value in 1977 was $16.7m. The Southern Comfort may be overvalued for this price. This acquisition should be further investigated more as a strategic acquisition, and depend upon the company’s post-performance. Brown-Forman’s hurdle rate is too high implying that the company is very conservative to make the decision. It is recommended that the company should adjust this hurdle rate, or they could miss out on important opportunities such as Southern Comfort. The Brown-Forman want to use a significant amount fee spend in advertising to market the Southern Comfort brand more aggressively. That will be a problem; the company may run out of liquidity. Company should fully consider the culture, systems and processes of the Southern Comfort in the acquisition. The investors want to ensure that skills and capabilities are not lost. The management team is especially valuable as they have shown on the financial statement that they are able to run an efficient profitable business. Question 2

Based on the IRR analysis, the IRR that equated the cash flows to the $94.6 million sale price was approximately 15%. Using CAPM
Cost of Equity
Rf rate =| 8.00%
Beta =1.1
Re =14.27%
Cost of Debt
Tax rate =49.35%
Interest rate8.75%
Cost of Debt4.32%
Percentage of equity cost 65%
Percentage of debt cost35%
*The 10 year Treasury bond was used as the risk free rate and the geometric mean for the risk premium|

Working capital=current asset - current liability (not include cash和 notepayable) =601927-1120128=-518201
FCFF = EBIT (1-tax rate) + Depreciation – Capital Expenditure – Δ Working capital = 4371462+2439268+106878-4731989+518201
= 2703820 thousand
Terminal Value = FCFF / (hurdle rate – WACC) = 64223752.97 thousand Use the WACC equal to the discount rate
The Firm Value = FCFF / WACC + Terminal Value/ (1+ WACC)
= 83027480.57 thousand
From the FCFF, terminal cash flow and WACC analysis, we can see in the sensitivity table that we had discounted the cash flows...
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