Alcoa 2009 Annual Report Download - page 77

reporting units when testing for impairment, as management believes forecasted cash flows are the best indicator of
such fair value. A number of significant assumptions and estimates are involved in the application of the DCF model to
forecast operating cash flows, including markets and market share, sales volumes and prices, costs to produce, tax
rates, capital spending, discount rate, and working capital changes. Most of these assumptions vary significantly among
the reporting units. Cash flow forecasts are generally based on approved business unit operating plans for the early
years and historical relationships in later years. The betas used in calculating the individual reporting units’ weighted
average cost of capital (WACC) rate are estimated for each business with the assistance of valuation experts.
In 2009, the estimated fair values of all nine reporting units were in excess of their carrying values, resulting in no
impairment. The impairments tests yielded similar results between 2009 and 2008, including a smaller excess for
Primary Metals than had been the case historically. In 2008, the excess of the estimated fair value of Primary Metals
over its carrying value was substantially less than in prior years due to the unprecedented decline in the LME price that
occurred in the second half of the year. Historically, LME pricing levels and corresponding input costs (e.g., raw
materials, energy) have generally trended in the same manner, resulting in relatively consistent cash margins over time.
However, the decline in the LME price significantly outpaced any decreases in associated input costs, causing expected
cash margins in the early years in the DCF model to be lower than normal and lower than long-term expectations. In
2009, the LME price increased gradually throughout the year and exceeded $2,000 (in whole dollars) per metric ton by
the end of the year, resulting in higher undiscounted expected future cash flows for Primary Metals, as the historical
trend between LME pricing levels and input costs began to return. However, Primary Metals’ WACC, the measure
used by Alcoa to discount expected future cash flows, increased from 8.4% in 2008 to 10.4% in 2009, effectively
negating the positive impact the rising LME price had on expected future cash flows. As a result, Primary Metals’ fair
value continued to exceed its carrying value even though the excess has not yet returned to levels prior to 2008.
In the event the estimated fair value of a reporting unit per the DCF model is less than the carrying value, additional
analysis would be required. The additional analysis would compare the carrying amount of the reporting unit’s
goodwill with the implied fair value of that goodwill, which may involve the use of valuation experts. The implied fair
value of goodwill is the excess of the fair value of the reporting unit over the fair value amounts assigned to all of the
assets and liabilities of that unit as if the reporting unit was acquired in a business combination and the fair value of the
reporting unit represented the purchase price. If the carrying value of goodwill exceeds its implied fair value, an
impairment loss equal to such excess would be recognized, which could significantly and adversely impact reported
results of operations and shareholders’ equity.
Equity investments. Alcoa invests in a number of privately-held companies, primarily through joint ventures and
consortiums, which are accounted for on the equity method. The equity method is applied in situations where Alcoa
has the ability to exercise significant influence, but not control, over the investee. Management reviews equity
investments for impairment whenever certain indicators are present suggesting that the carrying value of an investment
is not recoverable. This analysis requires a significant amount of judgment from management to identify events or
circumstances indicating that an equity investment is impaired. The following items are examples of impairment
indicators: significant, sustained declines in an investee’s revenue, earnings, and cash flow trends; adverse market
conditions of the investee’s industry or geographic area; the investee’s ability to continue operations measured by
several items, including liquidity; and other factors. Once an impairment indicator is identified, management uses
considerable judgment to determine if the impairment is other than temporary, in which case the equity investment is
written down to its estimated fair value. An impairment that is other than temporary could significantly and adversely
impact reported results of operations.
Properties, Plants, and Equipment. Properties, plants, and equipment are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of such assets (asset group) may not be recoverable.
Recoverability of assets is determined by comparing the estimated undiscounted net cash flows of the operations
related to the assets (asset group) to their carrying amount. An impairment loss would be recognized when the carrying
amount of the assets (asset group) exceeds the estimated undiscounted net cash flows. The amount of the impairment
loss to be recorded is calculated as the excess of the carrying value of the assets (asset group) over their fair value, with
fair value determined using the best information available, which generally is a DCF model. The determination of what
constitutes an asset group and the associated estimated undiscounted net cash flows also require significant judgments.
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