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BROWN-FORMAN DISTILLERS CORPORATION

In early July 1978, W. L. Lyons Brown, Jr., president and chief executive officer of Brown-Forman Distillers Corporation, faced an important acquisition decision. The principal owners of Southern Comfort Corporation had approached Brown in May with an offer to sell the company at a price of $94.6 million. In preparing his response, Brown was evaluating the feasibility of the asking price and the likely effects of the acquisition on Brown-Forman’s share price.

As a leading producer, marketer, and importer of wines and distilled spirits (including the well-known Jack Daniel’s brand), Brown-Forman ($457 million net sales) was the fifth-largest distiller in the United States, after National Distillers ($586 million), Seagram ($2,018 million), Heublein ($839 million), and Hiram Walker ($875 million).[1] How Brown had chosen to position Brown-Forman among its competitors would affect the appraisal of Southern Comfort.

Brown-Forman: Financial Goals and Performance

In 1977, Brown-Forman’s management adopted new long-range financial goals regarding: (1) hurdle rates for investment; (2) size of the capital budget through 1980; (3) target capital structure; and (4) dividend payout. The primary objective of these goals was to “increase the value of the stockholders’ investment.”[2]

The dividend payout ratio (all dividends paid divided by net income) was targeted at a range of 30% to 35%. Planned investment during the 1978 to 1980 period included $86 million for advertising and promotion, $39 million in barreled-whiskey inventory, and $19 million in new plant and equipment. Regarding capital structure, the ratio of total debt to total tangible capital,[3] 26.6% at the end of 1977, was viewed as offering “considerable flexibility in financing investment opportunities with either debt or equity.”[4] Finally, the target hurdle rate, calculated as the return on total capital employed,[5] was set at 14% for new capital...