Calculate the WACC and estimate future cash flows to value Southern Comfort Corporation. (Assume the deal will be completed at the end of 1978, making 1979 the first year of the future cash flows. Ignore the effects of preferred stock.) Accept the $94.6 million offer to acquire Southern Comfort? Why or why not?
The president and CEO of Brown-Forman Distillers Corporation, W.L. Lyons Brown, Jr., faced a very significant decision regarding an acquisition in July 1978. Southern Comfort Corporation approached the president and CEO of Brown-Forman Distillers Corporation in May. The owners of Southern Comfort offered to sell the company at a price of $94.6 million. Should Brown-Forman Distillers Corporation accept the $94.6 million offer in order to acquire Southern Comfort? In order to make a final decision, Brown-Forman Distillers Corporation needs to calculate the weighted average cost of capital and estimate the future cash flows to value Southern Comfort Corporation.
The first thing that the corporation should do is calculate the weighted average cost of capital (WACC).
This is calculated by finding the cost of equity and the cost of debt. According to Exhibit 1 of the case, Brown-Forman has a beta of 1.10, a market risk premium of 7.08%, and a risk free rate of 8.70%. Therefore, the cost of equity is 16.49%. The tax rate is 50% and the interest rate is 8.75%. Therefore, the cost of debt is 8.75%. The percent of equity cost is 20%, which means the percent of debt cost is 80%. By using all of this information, the weighted average cost of capital can be calculated. The WACC ends up being 14.07%.
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Next, the corporation needs to estimate future cash flows in order to see if they should accept the $94.6 million offer to acquire Southern Comfort. Exhibit 9 in the case shows the assumptions used in the Southern Comfort cash flow forecast. I calculated profit per US case, the profit per export case, the profit per Canada case, and the total gross profit in millions. Attached is a table that shows how each was calculated. I then created another table to find the free cash flow.
The total gross profit per year minus corporate expenses is equal to the EBIT. The taxes need to be subtracted from the EBIT, which is equal to the EBITA. There is no depreciation, but there are some additions to working capital that need to be subtracted and/or added in order to obtain the final free cash flow for each year. The attached table labeled “DCF Valuation of Southern Comfort Corporation” shows the estimations for the future cash flows.
Ultimately, Brown-Forman Distillers Corporation needs to make a decision on whether or not they should accept the $94.6 million offer to acquire Southern Comfort Corporation. The investment
