GE 2010 Annual Report Download - page 94

92 GE 2010 ANNUAL REPORT
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therefore, the second step of the impairment test was not required
to be performed and no goodwill impairment was recognized.
Our Real Estate reporting unit had a goodwill balance of
$1,089 million at December 31, 2010. As of July 1, 2010, the carry-
ing amount exceeded the estimated fair value of our Real Estate
reporting unit by approximately $3.2 billion. The estimated fair
value of the Real Estate reporting unit is based on a number of
assumptions about future business performance and investment,
including loss estimates for the existing finance receivable and
investment portfolio, new debt origination volume and margins,
and anticipated stabilization of the real estate market allowing
for sales of real estate investments at normalized margins. Our
assumed discount rate was 12% and was derived by applying a
capital asset pricing model and corroborated using equity analyst
research reports and implied cost of equity based on forecasted
price to earnings per share multiples for similar companies. Given
the volatility and uncertainty in the current commercial real
estate environment, there is uncertainty about a number of
assumptions upon which the estimated fair value is based. Differ-
ent loss estimates for the existing portfolio, changes in the new
debt origination volume and margin assumptions, changes in the
expected pace of the commercial real estate market recovery, or
changes in the equity return expectation of market participants
may result in changes in the estimated fair value of the Real
Estate reporting unit.
Based on the results of the step one testing, we performed the
second step of the impairment test described above. Based on
the results of the second step analysis for the Real Estate report-
ing unit, the estimated implied fair value of goodwill exceeded the
carrying value of goodwill by approximately $3.5 billion. Accord-
ingly, no goodwill impairment was required. In the second step,
unrealized losses in an entity’s assets have the effect of increas-
ing the estimated implied fair value of goodwill. The results of the
second step analysis were attributable to several factors. The
primary driver was the excess of the carrying value over the
estimated fair value of our Real Estate equity investments, which
approximated $6.3 billion at that time. Other drivers for the favor-
able outcome include the unrealized losses in the Real Estate
finance receivable portfolio and the fair value premium on the
Real Estate reporting unit allocated debt. The results of the sec-
ond step analysis are highly sensitive to these measurements, as
well as the key assumptions used in determining the estimated
fair value of the Real Estate reporting unit.
Estimating the fair value of reporting units requires the use of
estimates and significant judgments that are based on a number
of factors including actual operating results. If current conditions
persist longer or deteriorate further than expected, it is reason-
ably possible that the judgments and estimates described above
could change in future periods.
each business. Actual results may differ from those assumed in
our forecasts. We derive our discount rates using a capital asset
pricing model and analyzing published rates for industries relevant
to our reporting units to estimate the cost of equity financing. We
use discount rates that are commensurate with the risks and
uncertainty inherent in the respective businesses and in our
internally developed forecasts. Discount rates used in our report-
ing unit valuations ranged from 9% to 14.5%. Valuations using
the market approach reflect prices and other relevant observable
information generated by market transactions involving compa-
rable businesses.
Compared to the market approach, the income approach more
closely aligns each reporting unit valuation to our business profile,
including geographic markets served and product offerings.
Required rates of return, along with uncertainty inherent in the
forecasts of future cash flows, are reflected in the selection of
the discount rate. Equally important, under this approach, reason-
ably likely scenarios and associated sensitivities can be developed
for alternative future states that may not be reflected in an observ-
able market price. A market approach allows for comparison to
actual market transactions and multiples. It can be somewhat
more limited in its application because the population of potential
comparables is often limited to publicly-traded companies where
the characteristics of the comparative business and ours can be
significantly different, market data is usually not available for
divisions within larger conglomerates or non-public subsidiaries
that could otherwise qualify as comparable, and the specific
circumstances surrounding a market transaction (e.g., synergies
between the parties, terms and conditions of the transaction, etc.)
may be different or irrelevant with respect to our business. It can
also be difficult, under certain market conditions, to identify
orderly transactions between market participants in similar busi-
nesses. We assess the valuation methodology based upon the
relevance and availability of the data at the time we perform
the valuation and weight the methodologies appropriately.
We performed our annual impairment test of goodwill for all of
our reporting units in the third quarter using data as of July 1,
2010. The impairment test consists of two steps: in step one, the
carrying value of the reporting unit is compared with its fair value;
in step two, which is applied when the carrying value is more than
its fair value, the amount of goodwill impairment, if any, is derived
by deducting the fair value of the reporting unit’s assets and
liabilities from the fair value of its equity, and comparing that
amount with the carrying amount of goodwill. In performing the
valuations, we used cash flows that reflected management’s
forecasts and discount rates that included risk adjustments con-
sistent with the current market conditions. Based on the results of
our step one testing, the fair values of each of the GE Industrial
reporting units and the CLL, Consumer, Energy Financial Services
and GECAS reporting units exceeded their carrying values;