Sears 2010 Annual Report Download - page 56

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SEARS HOLDINGS CORPORATION
Notes to Consolidated Financial Statements—(Continued)
its carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment
has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows;
a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal
factors or in the business climate; unanticipated competition; and the testing for recoverability of a significant
asset group within a reporting unit. Any adverse change in these factors could have a significant impact on the
recoverability of these assets and could have a material impact on our consolidated financial statements.
Goodwill Impairment Assessments
Our goodwill resides in multiple reporting units. The goodwill impairment test involves a two-step process.
The first step is a comparison of each reporting unit’s fair value to its carrying value. We estimate fair value
using the best information available, using both a market participant approach, as well as a discounted cash flow
model, commonly referred to as the income approach. The market participant approach determines the value of a
reporting unit by deriving market multiples for reporting units based on assumptions potential market participants
would use in establishing a bid price for the unit. This approach therefore assumes strategic initiatives will result
in improvements in operational performance in the event of purchase, and includes the application of a discount
rate based on market participant assumptions with respect to capital structure and access to capital markets. The
income approach uses a reporting unit’s projection of estimated operating results and cash flows that is
discounted using a weighted-average cost of capital that reflects current market conditions. The projection uses
management’s best estimates of economic and market conditions over the projected period, including growth
rates in sales, costs, estimates of future expected changes in operating margins and cash expenditures. Other
significant estimates and assumptions include terminal value growth rates, future estimates of capital
expenditures and changes in future working capital requirements. Our final estimate of fair value of reporting
units is developed by equally weighting the fair values determined through both the market participant and
income approaches.
If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment
may exist and the second step must be performed to measure the amount of impairment loss. The amount of
impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of
the goodwill in the same manner as if the reporting unit was being acquired in a business combination. See Notes
13 and 14 to the Consolidated Financial Statements for further information regarding goodwill and related
impairment charges recorded during 2008.
Intangible Asset Impairment Assessments
We consider the income approach when testing intangible assets with indefinite lives for impairment on an
annual basis. We determined that the income approach, specifically the relief from royalty method, was most
appropriate for analyzing our indefinite-lived assets. This method is based on the assumption that, in lieu of
ownership, a firm would be willing to pay a royalty in order to exploit the related benefits of this asset class. The
relief from royalty method involves two steps: (i) estimation of reasonable royalty rates for the assets and (ii) the
application of these royalty rates to a net sales stream and discounting the resulting cash flows to determine a
value. We multiplied the selected royalty rate by the forecasted net sales stream to calculate the cost savings
(relief from royalty payment) associated with the assets. The cash flows are then discounted to present value by
the selected discount rate and compared to the carrying value of the assets.
Financial Instruments and Hedging Activities
We are exposed to fluctuations in foreign currency exchange rates as a result of our net investment in Sears
Canada. Further, Sears Canada is exposed to fluctuations in foreign currency exchange rates due to inventory
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