Morris Mining

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- Is impairment testing based strictly on discounted cash flow models?

No, the impairment testing is not based strictly on discounted cash flow models in Morris Mining case, though the discounted cash flow model has been proved to be more reasonable when market approach and cost approach cannot be applied. For discounted cash flow model, several factors should be adjusted to reflect the current market conditions. The first factor is the discount rate. Discount rate is affected by many economic inputs such as interest rate, inflation rate, and the company’s weighted average cost of capital. Another factor affecting the fair value of the patent is the expected sales for the mining machine over the useful life of the patent. The fluctuation in the sales revenue in later years will result in the change in the net present value of the patent. For the market approach and the cost approach, since there is no identical patent or replacement in the current market as of now, the discounted cash flow model seems to be more suitable for the case. However, in later years, when identical patent or replacement is developed, the fair value of the patent can be easily estimated with these two models. Therefore, the impairment testing can be based on market approach or cost approach if identical patent or replacement becomes available in the market.

- Is there some other way to determine fair value of this patent?

Yes, there are three different approaches—market approach, cost approach, and income approach. The market approach would value the patent based on sales of similar assets or patents in the market. In this case, the patent is so unique in the market and it is very difficult to find similar patent to compare. The cost approach would measure the fair value of the patent based on the costs that would be necessary to replace it. Morris Mining Corporation cannot use this approach because the patent cannot be replaced just like any other assets. Moreover, King Co. didn’t track the patent’s development cost separately, it becomes impossible to give an accurate number of the cost of the patent. Therefore, the income approach for the patent in Morris Mining Corporation case is the best choice.