Valuation for Financial Reporting : Fair Value Measurements and ...

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Case Study 1: Determining Goodwill and Other Intangible Assets 99Exhibit 3.15Target Company Valuation Summary as of December 31, 2006 ($000s)Percent toPurchaseReturn PriceFairValueASSET NAMECurrent Assets $41,500Debt-free Current Liabilities 25,000WeightedReturnNet Working Capital 16,500 5.00% 9.0% 0.45%Land and Buildings 22,000 7.00% 12.0% 0.84%Machinery and Equipment, net 19,000 8.00% 10.3% 0.83%TOTAL NET WORKING CAPITAL $57,500AND TANGIBLE ASSETSSoftware $7,120 17.00% 3.9% 0.66%Technology 16,560 18.00% 9.0% 1.62%In-process Research and Development 4,530 20.00% 2.5% 0.49%Trade Name 12,660 16.00% 6.9% 1.10%Customer Base 7,090 17.00% 3.9% 0.66%Assembled Workforce 1,790 16.00% 1.0% 0.16%Noncompete Agreement 2,720 16.00% 1.5% 0.24%TOTAL INTANGIBLE ASSETS $52,470(1) GOODWILL (excluding$74,030 23.00% 40.2% 9.25%assembled workforce)TOTAL $184,000 16.28%Footnote:(1) For financial reporting purposes, the fair value of goodwill includes the fair value ofassembled workforce for a total fair value of residual goodwill of $75.820 million.Note: Some amounts may not foot due to rounding.# Copyright 2007 by FVG Holdings, LC and Financial Valuation Solutions, LLC. All rights reserved. Used with permission.The returns for each asset are those actually used in the foregoing valuationmethodology (i.e., for tangible assets and contributory intangible assets). For contributoryintangible assets that were valued using a form of the income approach (tradename and noncompete agreement), the return is equal to the discount rate used tovalue that asset. Finally, the return for the assets valued under the excess earningsapproach is also their discount rate.It should be clear that the one asset that does not have a return is goodwill, and,admittedly, the return assigned is determined by trial and error. Essentially, thegoodwill return is imputed based on determination of the overall weighted returnneeded to equal the WACC. By its nature, goodwill is the riskiest asset of the group,and therefore should require a return much higher than the overall business return. If a
100 Valuation for Financial Reportinggoodwill return of, say, 10% is required to achieve a weighted return of approximately16%, this signals a problem, and the analyst will have to go back and review and revisehis or her work—something is wrong! Thus, in this calculation, the goodwill return of23% suggests that goodwill is substantially riskier than all of the other assets, but, at areturn of 23%, it is still well within reason for a proven going concern. Thus, we aresatisfied that the returns chosen for each asset are reasonable.CASE STUDY 2: IMPAIRMENT UNDER SFAS NO. 142SFAS No. 142 requires goodwill (and other indefinitely lived intangibles) to be testedat least annually for impairment. The first step of the two-step impairment test, used toidentify potential impairment, compares the fair value of the reporting unit with itscarrying amount, including goodwill. 20 If the carrying value of the reporting unitexceeds its fair value, step two is triggered. The second step of the goodwill impairmenttest requires determining the amount of goodwill impairment associated withthe impairment of the fair value of the reporting unit. 21 All long-lived assets must betested for impairment before the goodwill impairment test. Step two involvespreparing what amounts to a new purchase price allocation, and it is possible that,if the fair value of the reporting unit is impaired, some of the recorded asset fair valuesmay also be impaired.In this section an impairment test is presented, assumed to be one year later, of theentity valued in Case Study 1: Determining Goodwill and Other Intangible Assets in aBusiness Combination. In this example, the reporting unit and the business enterpriseare the same; thus, the impairment test is done at the enterprise level. Largercompanies will have multiple reporting units that must be separately analyzed.Our sample company is private, and we have determined that the best tool availableis a DCF.Obviously, the universe of acquired and acquirees is not limited to privatecompanies. If the reporting entity is public, the first thing management is going tolook at is the stock price. Certainly, a material decline in a company’s stock price mayindicate something is amiss and may be evidence enough to trigger step one of theimpairment test—determining the total impairment of the reporting unit. Many publiccompanies may observe a decline in their stock price between the two dates, but it isnot sufficient to simply quantify the price decline of the stock and conclude that is theimpairment amount. The reporting unit must be analyzed in detail to determinepermanent impairment. A decline in the stock price may indicate something is wrong,but further analysis must be performed to determine how much, if any, of theimpairment is permanent or temporary.Chapter 2 discusses the types of events that might indicate impairment of the fairvalue of the reporting unit. This example is presented to acquaint the reader with themechanics of SFAS No. 142 impairment testing. While the initial triggers indicatingstep two may differ depending on whether the company is public or private (a materialdecline in the stock price for the former and an analysis of business fundamentals for
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210 IndexBusiness Enterprise Analys
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214 IndexLong-termcapital, 71debt,
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