Brown Forman Distillers Corporation Harvard Case Solution & Analysis

Problem Statement

            Southern comfort has approached Brown Co with an intention that Brown Co could purchase Southern Co and cold give its shareholders an acceptable value of its shares .Being working in the same market with similar product line as Southern Co also deals in alcohol beverages and a lot of similarities as the passage mentions Brown co resembles Southern Co as both had a Southern heritage and an excellent performance record.

The main decision which needs to be made by Brown Co is that should it opt to buy Southern Co shares and if yes what Payment method should be used by them.


Alternative approaches for valuing Southern Co:

            There are a number of approaches that can be applied in valuing Southern Comfort Corporation but it must be borne in mind that the valuation techniques used merely give a rough idea about the amount from where negotiation could start from,so this should not be overemphasize the actual final amount would be a resultant of bargains and negotiations over a number of terms. Some of the most widely used methods are listed below:

1- Price per earning based valuation model

            In P/E valuation model, the market value of the companies’ shares can be derived by multiplying the earning per share of the company by its P/E ratio. The earning per share can be derived by dividing the net profit after interest and tax by the total number of shares of the company. The P/E of proxy companies is used most of the times or for better results P/E of the industry is used which is as in our case of bear industry.

            Average Market value per share/Average Earnings per share shows how well the company is performing in comparison to its peers.The price per earning method to value a company is not considered to be of relatively high accuracy but it surely gives an approximation figure which can be easily understood by managers who are not very familiar with financial terms and complex calculations which are not easily understood.

            There are a number of weaknesses in P/E valuation the most important one is that it is based upon historical figures unlike the discounted cash flow technique or the free cash flow technique which is based upon future projections.

2-Assets Based Approach

            In asset based valuation the basic idea being this is that the value of the business is worth only its net assets,i.e. assets – liabilities. This valuation method is only used as an initial negation figure or in other words what the business is at-least worth of buying on its lowest terms.

            Asset based valuation only gives us the value which we had if the company sells all its assets, settles all of its liabilities and the left over is what shareholders are expected to receive by the buyers; but as we know practically shareholders demand premium. Therefore Southern Comfort seems to be a strong brand with high sales margin and good market reputationtherefore, its shareholders will definitely demand a premium over their share price if the company is to be sold.

3-Dividend Valuation Based Approach

            The dividend valuation model suggests that the value of a company should be equated by calculating the present value of the dividends through the required return of the equity holders i.e. (ken) with implied growth in dividends if there is any. The formula is P=D (1+g)/KE-g where,

P=market value of share

D=dividend per share

Key=required rate of return byshareholders calculated as ke=rf+ (rm-rf)*be

Where g= the growth rate of future dividends calculated as {(current div)/ (ex-div)} ^1/n -1

            There are a number of weaknesses in dividend valuation model as it is based upon past dividend growth rates and it is heavily dependent upon Ke for its calculation which its self is derived after several implied assumptions about the risk free rate of return, the market based rate of return and the appropriateness of the equity beta.

Brown Forman Distillers Corporation Case Solution

4-Valuation based upon the free cash flow.

            The free cash flow methodology for calculating the value Southern Comfort Corporation is the most appropriate and accurate approach.The basic idea behind free cash flow methodology is that net operating profit after tax is used then after deducting re- investments, adding back non-cash items like depreciation,the final figure shows the amount which is available to the providers of capital. .......................................

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