Progress Energy 2010 Annual Report Download - page 29

25
Progress Energy Annual Report 2010
April 1 to October 31 to better align our impairment testing
procedures with the completion of our annual financial and
strategic planning process. As a result, during 2010, we
tested our goodwill for impairment as of October 31, 2010
and April 1, 2010, and concluded there was no impairment
of the carrying value of the goodwill. If the estimated fair
values of PEC and PEF on those dates had been lower by
10 percent, there still would be no impact on the reported
value of their goodwill. In addition, based on the results of
impairment tests performed in April 2009 and April 2008,
we concluded there was no impairment of the carrying
value of the goodwill in the prior periods presented in
the consolidated financial statements. This change in
accounting principle did not accelerate, delay, avoid, or
cause a goodwill impairment charge.
We calculate the fair value of our utility reporting units by
considering various factors, including valuation studies
based primarily on income and market approaches.
More emphasis is applied to the income approach as
substantially all of the Utilities’ cash flows are from rate-
regulated operations. In such environments, revenue
requirements are adjusted periodically by regulators
based on factors including levels of costs, sales volumes
and costs of capital. Accordingly, the Utilities operate
to some degree with a buffer from the direct effects,
positive or negative, of significant swings in market or
economic conditions.
The income approach uses discounted cash flow
analyses to determine the fair value of the utility reporting
units. The estimated future cash flows from operations
are based on the Utilities’ business plans, which reflect
management’s assumptions related to customer usage
based on internal data and economic data obtained
from third-party sources. The business plans assume
the occurrence of certain events in the future, such as
the outcome of future rate filings, future approved rates
of returns on equity, the timing of anticipated significant
future capital investments, the anticipated earnings and
returns related to such capital investments, continued
recovery of cost of service and the renewal of certain
contracts. Management also determines the appropriate
discount rate for the utility reporting units based on the
weighted average cost of capital for each utility, which
takes into account both the cost of equity and pre-tax
cost of debt. As each utility reporting unit has a different
risk profile based on the nature of its operations, the
discount rate for each reporting unit may differ.
The market approach uses implied market multiples
derived from comparable peer utilities and market
transactions to estimate the fair value of the utility
reporting units. Peer utilities are evaluated based on
percentage of revenues generated by regulated utility
operations; percentage of revenues generated by
electric operations; generation mix, including coal,
gas,฀nuclear฀and฀other฀resources;฀market฀capitalization฀
as of the valuation date; and geographic location.
Comparable market transactions are evaluated based
on the availability of financial transaction data and the
nature and geographic location of the businesses or
assets acquired, including whether the target company
had a significant electric component. The selection of
comparable peer utilities and market transactions, as
well as the appropriate multiples from within a reasonable
range, is a matter of professional judgment.
The calculations in both the income and market
approaches are highly dependent on subjective factors
such as management’s estimate of future cash flows,
the selection of appropriate discount and growth rates
from a marketplace participant’s perspective, and the
selection of peer utilities and marketplace transactions
for comparative valuation purposes. These underlying
assumptions and estimates are made as of a point in
time. If these assumptions change or should the actual
outcome of some or all of these assumptions differ
significantly from the current assumptions, the fair
value of the utility reporting units could be significantly
different in future periods, which could result in a future
impairment charge to goodwill.
As an overall test of the reasonableness of the estimated
fair values of the utility reporting units, we compared
their combined fair value estimate to Progress Energy’s
market฀capitalization฀as฀of฀October฀31,฀2010฀and฀April฀1,฀
2010. The analyses confirmed that the fair values were
reasonably representative of market views when
applying a reasonable control premium to the market
capitalization.฀
We monitor for events or circumstances, including
financial market conditions and economic factors, that
may indicate an interim goodwill impairment test is
necessary. We would perform an interim impairment
test should any events occur or circumstances change
that would more likely than not reduce the fair value
of a utility reporting unit below its carrying value. As
a result of the Merger Agreement discussed within
MD&A – “Introduction – Merger” and in Note 25, we
considered whether an interim goodwill impairment test
was necessary. Based upon reasonable allocations of
the Merger consideration to PEC and PEF, we concluded