Wendy's 2010 Annual Report Download - page 69

We believe that the following represent our more critical estimates and assumptions used in the preparation of
our consolidated financial statements:
• Goodwill impairment:
The Companies operate in two business segments consisting of two restaurant brands: (1) Wendy’s
restaurant operations and (2) Arby’s restaurant operations. In 2010, the Arby’s segment included
company-owned restaurants and franchise reporting units and the Wendy’s segment included Wendy’s
North America and international restaurant reporting units. As of January 2, 2011, substantially all
Wendy’s goodwill of $866.0 million was associated with its North America reporting unit and Arby’s
goodwill of $17.6 million relates entirely to the its franchise reporting unit.
We test goodwill for impairment annually, or more frequently if events or changes in circumstances
indicate that the asset may be impaired using a two-step process. Under the first step, the fair value of the
reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting
unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and
we must perform step two of the impairment test (measurement). Step two of the impairment test, if
necessary, requires the estimation of the fair value for the assets and liabilities of a reporting unit in order
to calculate the implied fair value of the reporting unit’s goodwill. Under step two, an impairment loss is
recognized to the extent the carrying amount of the reporting unit’s goodwill exceeds the implied fair value
of goodwill. The fair value of the reporting unit is determined by management and is based on the results
of (1) estimates we made regarding the present value of the anticipated cash flows associated with each
reporting unit (the “income approach”) and (2) the indicated value of the reporting units based on a
comparison and correlation of the Companies and other similar companies (the “market approach”).
The income approach, which considers factors unique to each of our reporting units and related long range
plans that may not be comparable to other companies and that are not yet publicly available, is dependent
on several critical management assumptions. These assumptions include estimates of future sales growth,
gross margins, operating costs, income tax rates, terminal value growth rates, capital expenditures and the
weighted average cost of capital (discount rate). Anticipated cash flows used under the income approach
are developed every fourth quarter in conjunction with our annual budgeting process and also incorporate
amounts and timing of future cash flows based on our long range plan.
The discount rates used in the income approach are an estimate of the rate of return that a market
participant would expect of each reporting unit. To select an appropriate rate for discounting the future
earnings stream, a review was made of short-term interest rate yields of long-term corporate and
government bonds, as well as the typical capital structure of companies in the industry. The discount rates
used for each reporting unit may vary depending on the risk inherent in the cash flow projections, as well
as the risk level that would be perceived by a market participant. A terminal value is included at the end of
the projection period used in our discounted cash flow analyses to reflect the remaining value that each
reporting unit is expected to generate. The terminal value represents the present value in the last year of the
projection period of all subsequent cash flows into perpetuity. The terminal value growth rate is a key
assumption used in determining the terminal value as it represents the annual growth of all subsequent
cash flows into perpetuity.
Under the market approach, we apply the guideline company method in estimating fair value. The
guideline company method makes use of market price data of corporations whose stock is actively traded
in a public market. The corporations we selected as guideline companies are engaged in a similar line of
business or are subject to similar financial and business risks, including the opportunity for growth. The
guideline company method of the market approach provides an indication of value by relating the equity
or invested capital (debt plus equity) of guideline companies to various measures of their earnings and cash
flow, then applying such multiples to the business being valued. The result of applying the guideline
company approach is adjusted based on the incremental value associated with a controlling interest in the
business. This “control premium” represents the amount a new controlling shareholder would pay for the
benefits resulting from synergies and other potential benefits derived from controlling the enterprise.
We performed our annual goodwill impairment test in the fourth quarter of 2010. Our assessment of
goodwill of the Wendy’s North America Restaurants in the fourth quarter of 2010 indicated that there had
been no impairment and that the fair value of this reporting unit of $3,080 million was approximately
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