Alcoa 2011 Annual Report Download - page 93

During the 2011 annual review of goodwill, management performed the qualitative assessment for six reporting units.
Management concluded that it was not more likely than not that the estimated fair values of the six reporting units were
less than their carrying values. As such, no further analysis was required.
Under the two-step quantitative impairment test, the evaluation of impairment involves comparing the current fair
value of each reporting unit to its carrying value, including goodwill. Alcoa uses a DCF model to estimate the current
fair value of its 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’ WACC rate are estimated for each business with the assistance of valuation experts.
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.
During the 2011 annual review of goodwill, management proceeded directly to the two-step quantitative impairment
test for three reporting units as follows: the Primary Metals segment, building and construction systems, which is
included in the Engineered Products and Solutions segment, and the soft alloy extrusions business in Brazil. The
estimated fair values of these three reporting units were substantially in excess of their carrying values, resulting in no
impairment.
As part of the 2011 annual review of goodwill, management considered the market capitalization of Alcoa’s common
stock in relation to the Company’s total shareholders’ equity. At December 31, 2011, the market capitalization of
Alcoa’s common stock was $9,207. While this amount is less than the Company’s total shareholders’ equity at
December 31, 2011, the estimated aggregate fair value of Alcoa’s reporting units was substantially in excess of the
aforementioned market capitalization amount. In management’s judgment, the main reasons for the difference between
Alcoa’s market capitalization and total shareholders’ equity at December 31, 2011 are the overall decline in the capital
markets and significantly lower commodity prices. As it relates to the capital markets, there was, and continues to be,
significant uncertainty of the sovereign debt of many European countries. This uncertainty has affected the liquidity of
many companies that either operate or are located in Europe, although, Alcoa has not been impacted significantly. The
combination of this uncertainty and the continuing decline in commodity prices caused significant and volatile
fluctuations in the price of Alcoa’s common stock. At December 31, 2011 and 2010, the market price of Alcoa’s
common stock was $8.65 and $15.39, respectively, which equates to a decline of 44%. During 2011, the size and
structure of the Company did not change and there were no specific events or transactions that would cause
management to reasonably expect such a decline in the market price of Alcoa’s common stock. As a result,
management believes the quoted market price of Alcoa’s common stock does not fully reflect the underlying value of
the future aggregate cash flows of the Company’s reporting units. Accordingly, management does not believe that the
comparison of Alcoa’s market capitalization and total shareholders’ equity as of December 31, 2011 is an indication
that goodwill is impaired.
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