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The Value of a Brand Name

From Net Income to Operating Income and Equity to Value

The profits margins for firms can be stated in terms of net income (as they have in all the
examples so far) or in terms of operating income (EBIT). If pre-tax operating margins are
used, the appropriate value estimate is that of the firm. In particular, if one makes the
assumption that

Free Cash Flow to the Firm = EBIT (1 - tax rate): Net Capital exp. and working capital
needs are zero.

Then the Value of the Firm can be written as a function of the after-tax operating
margin= (EBIT (1-t)/Sales


g = Growth rate in after-tax operating income for the first n years

gn = Growth rate in after-tax operating income after n years forever (Stable growth rate)

WACC = Weighted average cost of capital

The value of a brand name

• One of the critiques of valuation is that is fails to consider the value of brand
names and other intangibles.
• The approaches used by analysts to value brand names are often ad-hoc and may
significantly overstate or understate their value. Firms with well known brand
names often sell for higher multiples than lesser-known firms. The standard
practice of adding on a 'brand name premium', often set arbitrarily, to discounted
cashflow value, can lead to erroneous estimates.
• One of the benefits of having a well-known and respected brand name is that
firms can charge higher prices for the same products, leading to higher profit
margins and hence to higher price-sales ratios and firm value. The larger the price
premium that a firm can charge, the greater is the value of the brand name.

brand value is most commonly defined as the value added to the product by
the brand. I would define it more specifically, for measurement purposes, as
the relative ability of a brand to bias customer choice. In turn, a brand’s
value I would argue, depends on its ability to reliably indicate attributes of
value to a customer. In other words, a brand’s value - to customers – depends
on its ability to act as a reliable predictor of what to expect after purchase.

In general, the value of a brand name can be written as:

Value of brand name ={(V/S)b-(V/S)g }* Sales

(V/S)b = Value of Firm/Sales ratio of the firm with the benefit of the brand name

(V/S)g = Value of Firm/Sales ratio of the firm with the generic product

Illustration : Valuing a brand name: Kelloggs

The following is an analysis of brand name value at Kellogg Corporation. The estimates
for Kellogg were obtained from 1994 financial statements. The after-tax operating margin
for the generic substitute was obtained by looking at a private-brand cereal manufacturer.
The expected growth is assumed to be

Expected growth in after-tax operating income = Retention Ratio * Return on Assets

Kellogg's Generic Substitute

Pre-tax Operating Margin 22.00% 10.50%
After-tax Operating Margin 14.08% 6.72%
Return on Assets 32.60% 15.00%
Retention Ratio 56.00% 56.00%
Expected Growth 18.26% 8.40%

Length of High Growth Period 5 5

Cost of Equity 13.00% 13.00%

E/(D+E) 92.16% 92.16%
D/(D+E) 8.50% 8.50%
Value/Sales Ratio 3.39 1.10

Value of Kellogg Brand Name = ( 3.39 - 1.10) ($6562 million) = $15,026 million

Value of Kellogg as a company = 3.39 ($6562 million) = $22,271 million

Approximately 67.70% ($15026/$22271) of the value of the company can be traced to

brand name value
The danger of double-counting the value of a brand name
The value of a brand name results in higher growth and higher value for the firm owning
it. There are some analyses where the brand name value is double counted. To provide an
illustration of how this could happen, assume that Coca Cola is valued using a discounted
cashflow model and that the expected growth rate used in the valuation is 29.55%. This
value already incorporates the value of the brand name through the use of the high
growth rate. If an additional value is now assigned to the brand name, the brand name
value is double counted.