Xerox 2015 Annual Report Download - page 51

Business Combinations and Goodwill
The accounting for business combinations requires the use of significant estimates and assumptions in the
determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price
consideration between assets that are depreciated and amortized from goodwill. Our estimates of the fair values of
assets and liabilities acquired are based upon assumptions believed to be reasonable, and when appropriate,
include assistance from independent third-party valuation firms. Refer to Note 3 - Acquisitions in the Consolidated
Financial Statements for additional information regarding the allocation of the purchase price consideration for our
acquisitions.
As a result of our acquisition of Affiliated Computer Services, Inc. (ACS) in 2010, as well as other acquisitions
including GIS, we have a significant amount of goodwill. Goodwill at December 31, 2015 was $8.8 billion. Goodwill
is not amortized but rather is tested for impairment annually or more frequently if an event or circumstance indicates
that an impairment may have been incurred. Events or circumstances that might indicate an interim evaluation is
warranted include, among other things, unexpected adverse business conditions, macro and reporting unit specific
economic factors, supply costs, unanticipated competitive activities and acts by governments and courts.
Application of the annual goodwill impairment test requires judgment, including the identification of reporting units,
assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and the assessment-
qualitatively or quantitatively - of the fair value of each reporting unit against its carrying value. At December 31,
2015, $6.5 billion and $2.3 billion of goodwill was allocated to reporting units within our Services and Document
Technology segments, respectively. Our Services segment is comprised of five reporting units while our Document
Technology segment is comprised of one reporting unit for a total of six reporting units with goodwill balances.
Our annual impairment test of goodwill was performed in the fourth quarter of 2015. Consistent with 2014, we
elected to utilize a quantitative assessment of the recoverability of our goodwill balances for each of our reporting
units.
In our quantitative test, we estimate the fair value of each reporting unit by weighting the results from the income
approach (discounted cash flow methodology) and market approach. These valuation approaches require
significant judgment and consider a number of factors that include, but are not limited to, expected future cash
flows, growth rates and discount rates, and comparable multiples from publicly traded companies in our industry
and require us to make certain assumptions and estimates regarding the current economic environment, industry
factors and the future profitability of our businesses.
When performing our discounted cash flow analysis for each reporting unit, we incorporate the use of projected
financial information and discount rates that are developed using market participant-based assumptions. The cash-
flow projections are based on three-year financial forecasts developed by management that include revenue and
expense projections, capital spending trends and investment in working capital to support anticipated revenue
growth or other changes in the business. The selected discount rates consider the risk and nature of the respective
reporting units' cash flows and an appropriate capital structure and rates of return that market participants would
require to invest their capital in our reporting units.
In performing our 2015 impairment test, the following were the 3-year compounded assumptions for Document
Technology and the five reporting units within our Services segment with respect to revenue, operating income and
margins, which formed the basis for estimating future cash flows used in the discounted cash flow model:
• Document Technology - Continued revenue declines with a flattening over the long-term. Operating income - flat
and operating margin - 9% to 11% - as we continue to manage costs to match expected decline in revenues.
• Services - Revenues flat to single digit growth over the long-term, as we look to expand in key segments of the
outsourcing services market. Operating income growth - 11% to 12% - and operating margin - 9% to 10% - as
we benefit from revenue growth while improving the mix of services and our cost structure through restructuring
and productivity improvements.
We believe these assumptions are appropriate and reflect our forecasted long-term business model, giving
appropriate consideration to our historical results as well as the current economic environment and markets that we
serve. The average discount rate applied to our projected cash flows was approximately 9.0%, which we considered
reasonable based on the estimated capital costs of applicable market participants. Although the sum of the fair
values of our reporting units was in excess of our market capitalization, we believe the difference is reasonable
when market-based control premiums and other factors are taken into consideration, including the evolution of our
Xerox 2015 Annual Report 34