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Sprint Nextel 2007 Fair Value and Impairment. Earl K. Stice PricewaterhouseCoopers Professor of Accounting Brigham Young University 3 August 2008. Topics Covered in the Case. 6 questions address Impairment analysis and asset valuation (Questions 1 and 2) Fair value disclosures (Question 3)

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sprint nextel 2007 fair value and impairment

Sprint Nextel 2007Fair Value and Impairment

Earl K. Stice

PricewaterhouseCoopers Professor of Accounting

Brigham Young University

3 August 2008

topics covered in the case
Topics Covered in the Case

6 questions address

  • Impairment analysis and asset valuation (Questions 1 and 2)
  • Fair value disclosures (Question 3)
  • Valuation sensitivity analysis (Questions 4, 5, and 6)
developments during 2007
Developments During 2007

Operating income in each quarter in 2007 was down compared to the same quarter in 2006. Total decrease of 63%.

Average revenue per user (ARPU) declined during each quarter in 2007 compared to the same quarter in 2006.

The market value of the company dropped from $55 billion to $37 billion.

impairment analysis of ppe6
Impairment Analysis of PPE

According to SFAS No. 144, par. 18, “the remaining life of an asset group shall be based on the remaining useful life of the primary asset of the group.”

For the property, plant, and equipment of the Wireless segment, this asset is the network equipment.

Remaining useful life = 8 years

impairment analysis of ppe7
Impairment Analysis of PPE

Estimated annual lease payment = $4,250

$34,000 = 8 years × $4,250 per year.

$34,000 > $22,882

The Wireless segment’s property, plant, and equipment is NOT impaired.

impairment analysis of ppe8
Impairment Analysis of PPE

Where should students have questions about the data?

What is the source of the lease payment data?

8 years? Not 10 years? Not 5 years?

impairment analysis of goodwill
Impairment Analysis of Goodwill

Step 1 – fair value of Wireless segment greater than book value?

Step 2 (if necessary) – estimate fair values of all Wireless segment assets and liabilities.

Step 3 (if necessary) – recompute goodwill.

impairment analysis of goodwill indirect valuation
Impairment Analysis of GoodwillIndirect Valuation

“We [reduce] our stock price by the estimated value per share of our Wireline reporting unit and then [add] a control premium, as permitted by FASB guidance, to determine an estimate of the equity value of the Wireless reporting unit.”

impairment analysis of goodwill indirect valuation13
Impairment Analysis of GoodwillIndirect Valuation

Price-to-revenue multiple:

1.21 × 6.46 = $7.8 billion

Price-to-EBITDA multiple:

3.45 × 1.07 = $3.7 billion

The average of these two estimates is $5.8 billion = estimate of value of Wireline segment.

impairment analysis of goodwill indirect valuation15
Impairment Analysis of GoodwillIndirect Valuation

Book value of Wireless segment as of December 31, 2007:

$52.8 billion

Estimated market value of Wireless segment as of December 31, 2007:

$33 billion

Yes, goodwill may be impaired.

impairment analysis of goodwill indirect valuation16
Impairment Analysis of GoodwillIndirect Valuation

Where should students have questions about the data?

In this case, they should realize that the market value of the Wireless segment is substantially less than its book value no matter what assumptions are made.

impairment analysis of goodwill direct valuation
Impairment Analysis of GoodwillDirect Valuation

Sprint Nextel also estimates the market value of the Wireless segment through an income approach which involves the computation of the present value of an estimate of the cash flows to be generated by the segment.

impairment analysis of goodwill20
Impairment Analysis of Goodwill

Step 1 – Yes, goodwill may be impaired.

So, on to Step 2 which is estimating the fair values of all Wireless segment assets and liabilities.

valuation of fcc licenses
Valuation of FCC Licenses

“Relief from royalty” method

Use market royalty rates charged for the use of similar licenses.

The fair value of the licenses is the present value of the after-tax royalties that Sprint Nextel is avoiding by owning the licenses.

valuation of fcc licenses relief from royalty method
Valuation of FCC Licenses“Relief from Royalty” Method

Search in a proprietary royalty rate database

Rates ranging from 2% to 8%

Average rate of 4.2%

The royalty is based on revenue, before the subtraction of any expenses.

valuation of fcc licenses relief from royalty method25
Valuation of FCC Licenses“Relief from Royalty” Method

Estimated fair value of FCC licenses:

$29.100 billion

Book value of FCC licenses:

$21.123 billion

valuation of fcc licenses relief from royalty method26
Valuation of FCC Licenses“Relief from Royalty” Method

Where should students have questions about the data?

Royalty rate

Customer growth rate

Terminal year

Post-terminal year growth rate

Discount rate

valuation of customer relationships
Valuation of Customer Relationships

Excess cash flow valuation

Assume that other assets earn a normal return.

“Other assets” includes the fair values of both recognized and unrecognized assets.

Exclude goodwill.

valuation of customer relationships30
Valuation of Customer Relationships

Where should students have questions about the data?

Interesting question… we’ll see more about this in a moment.

new computation of goodwill35
New Computation of Goodwill

What is the AUDITOR’S responsibility with respect to this goodwill impairment number?

sfas no 157 disclosure37
SFAS No. 157 Disclosure

FCC licenses:

Book value = $21.123 billion

Fair value = $29.100 billion

Customer relationships:

Book value = $4.203 billion

Fair value = $7.499 billion

Why no fair value disclosure?

points to remember
Points to Remember

Our accounting students need to understand valuation models.

Experience with valuation models will teach our accounting students where the pressure points are.

Teaching about fair value is much more than teaching SFAS No. 157 disclosures.

eks@byu edu
eks@byu.edu

Email me if you want soft copies of this material.