1. Sprint Nextel 2007 Fair Value and Impairment
Earl K. Stice
PricewaterhouseCoopers Professor of Accounting
Brigham Young University
3 August 2008

2. Topics Covered in the Case
6 questions address
Impairment analysis and asset valuation (Questions 1 and 2)
Fair value disclosures (Question 3)
Valuation sensitivity analysis (Questions 4, 5, and 6)

3. Developments During 2007
Operating income in each quarter in 2007 was down compared to the same quarter in Total decrease of 63%.
Average revenue per user (ARPU) declined during each quarter in 2007 compared to the same quarter in 2006.
The market value of the company dropped from $55 billion to $37 billion.

4. Impairment Analysis of PPE

5. Impairment Analysis of PPE

6. Impairment Analysis of PPE
According to SFAS No. 144, par. 18, “the remaining life of an asset group shall be based on the remaining useful life of the primary asset of the group.”
For the property, plant, and equipment of the Wireless segment, this asset is the network equipment.
Remaining useful life = 8 years

7. Impairment Analysis of PPE
Estimated annual lease payment = $4,250
$34,000 = 8 years × $4,250 per year.
$34,000 > $22,882
The Wireless segment’s property, plant, and equipment is NOT impaired.

8. Impairment Analysis of PPE
Where should students have questions about the data?
What is the source of the lease payment data?
8 years? Not 10 years? Not 5 years?

9. Impairment Analysis of Goodwill
Step 1 – fair value of Wireless segment greater than book value?
Step 2 (if necessary) – estimate fair values of all Wireless segment assets and liabilities.
Step 3 (if necessary) – recompute goodwill.

10. Impairment Analysis of Goodwill Indirect Valuation
“We [reduce] our stock price by the estimated value per share of our Wireline reporting unit and then [add] a control premium, as permitted by FASB guidance, to determine an estimate of the equity value of the Wireless reporting unit.”

11. Impairment Analysis of Goodwill Indirect Valuation

12. Impairment Analysis of Goodwill Indirect Valuation

13. Impairment Analysis of Goodwill Indirect Valuation
Price-to-revenue multiple:
1.21 × 6.46 = $7.8 billion
Price-to-EBITDA multiple:
3.45 × 1.07 = $3.7 billion
The average of these two estimates is $5.8 billion = estimate of value of Wireline segment.

14. Impairment Analysis of Goodwill Indirect Valuation

15. Impairment Analysis of Goodwill Indirect Valuation
Book value of Wireless segment as of December 31, 2007:
$52.8 billion
Estimated market value of Wireless segment as of December 31, 2007:
$33 billion
Yes, goodwill may be impaired.

16. Impairment Analysis of Goodwill Indirect Valuation
Where should students have questions about the data?
In this case, they should realize that the market value of the Wireless segment is substantially less than its book value no matter what assumptions are made.

17. Impairment Analysis of Goodwill Direct Valuation
Sprint Nextel also estimates the market value of the Wireless segment through an income approach which involves the computation of the present value of an estimate of the cash flows to be generated by the segment.

18. Impairment Analysis of Goodwill Direct Valuation

19. Impairment Analysis of Goodwill Direct Valuation

20. Impairment Analysis of Goodwill
Step 1 – Yes, goodwill may be impaired.
So, on to Step 2 which is estimating the fair values of all Wireless segment assets and liabilities.

21. Valuation of FCC Licenses
“Relief from royalty” method
Use market royalty rates charged for the use of similar licenses.
The fair value of the licenses is the present value of the after-tax royalties that Sprint Nextel is avoiding by owning the licenses.

22. Valuation of FCC Licenses “Relief from Royalty” Method
Search in a proprietary royalty rate database
Rates ranging from 2% to 8%
Average rate of 4.2%
The royalty is based on revenue, before the subtraction of any expenses.

23. Valuation of FCC Licenses “Relief from Royalty” Method

24. Valuation of FCC Licenses “Relief from Royalty” Method

25. Valuation of FCC Licenses “Relief from Royalty” Method
Estimated fair value of FCC licenses:
$ billion
Book value of FCC licenses:
$ billion

26. Valuation of FCC Licenses “Relief from Royalty” Method
Where should students have questions about the data?
Royalty rate
Customer growth rate
Terminal year
Post-terminal year growth rate
Discount rate

27. Valuation of Customer Relationships
Excess cash flow valuation
Assume that other assets earn a normal return.
“Other assets” includes the fair values of both recognized and unrecognized assets.
Exclude goodwill.

28. Valuation of Customer Relationships

29. Valuation of Customer Relationships

30. Valuation of Customer Relationships
Where should students have questions about the data?
Interesting question… we’ll see more about this in a moment.

31. New Computation of Goodwill

32. New Computation of Goodwill

33. New Computation of Goodwill

34. New Computation of Goodwill

35. New Computation of Goodwill
What is the AUDITOR’S responsibility with respect to this goodwill impairment number?

36. SFAS No. 157 Disclosure

37. SFAS No. 157 Disclosure FCC licenses: Book value = $21.123 billion
Fair value = $ billion
Customer relationships:
Book value = $4.203 billion
Fair value = $7.499 billion
Why no fair value disclosure?

38. Points to Remember
Our accounting students need to understand valuation models.
Experience with valuation models will teach our accounting students where the pressure points are.
Teaching about fair value is much more than teaching SFAS No. 157 disclosures.

39.
me if you want soft copies of this material.