In July 1978, Brown-Forman Distillers Corporation was approached by the owners of Southern Comfort Corporation with an offer to sell the company at a price of $94.6 million. At the time of the offer, Brown-Forman was the fifth-largest distiller in the United States, but if Brown-Forman were to accept the offer, it would affect their competitive position.
In regards to the offer, Brown-Forman needed to make three key decisions: (1) should Brown-Forman acquire Southern Comfort Corporation, (2) if this is recommended, is $94.6 million a fair price to pay, and (3) what are the likely effects of the acquisition on the company’s stock price?
In 1977, Brown-Forman had adopted several long-term financial goals regarding their performance, most notably:
(1) Hurdle rates for investment: The target hurdle rate for investments (calculated as the return on total capital employed) was 14% for new capital projects in the distilling industry and 12% for investments in projects already in place,
(2) Size of the capital budget through 1980: Planned investment already included $86 million for advertising and promotion, $39 million in barreled whiskey inventory, and $19 million in new plant and equipment,
(3) Target Capital Structure: Total capital structure, which can be described as the ratio of total debt to total tangible capital, was targeted at 26.6%, and
(4) Dividend payout: The dividend payout ratio was targeted at a range of 30 to 35%.
These goals were included as criteria for our quantitative analysis of whether or not Brown-Forman should purchase Southern Comfort Corporation.
Free cash flow projections for the DCF analysis were provided within the case. To attribute value to the cash flows for the years beyond the projection period, a terminal value was calculated by capitalizing the normalized cash flows beyond 1988. The capitalization rate used was the discount rate less a four percent long-term...