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Valuation and Analysis of Dollar General

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Table of Contents
Executive Summary1 Overview of Dollar General6 Five Forces Model................................................9 Rivalry among Existing Firms................................9 Industry Growth.10 Concentration..10 Differentiation and Switching costs13 Scale Economies and Fixed/Variable Costs..13 Excess Capacity and Exit Barriers14 Threat of New Entrants..15 Economies of Scale.15 Channels of Distribution and Relationships..16 Legal Barriers17 Threat of Substitute products.17 Buyers willingness to switch17 Bargaining Power..18 Bargaining Power of the Customer...............................18 Switching Cost.18 Product Cost and Quality..19 Number of Buyers..19 Volume per Buyer..19 Bargaining Power of the Suppliers...20 Switching Cost...............................................20 Product Cost and Quality..20
3 Number of Suppliers....20

Value Chain Analysis...21 Efficient Production22 Simpler Product Design.22 Lower Input Costs....22 Low-cost Distribution...22 Minimal Brand Image Cost..23 Tight Cost Control..23 Firm Competitive Advantage Analysis....23

Efficient Production..24 Simpler Product Design.24 Lower Input Costs....24 Low-cost Distribution25 Minimal Brand Image Cost..25 Tight Cost Control..25 Conclusion...26

Accounting Analysis.......27 Key Accounting Policies.28 Degrees of accounting flexibility..30

Accounting Strategy...32 Quality of Disclosure..34 Identify Potential Red Flags...44 Undo Accounting Distortions.45

Financial Analysis.48 Trend and Cross Sectional Analysis48 Financial Ratio Analysis.49
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Liquidity Ratios..49
Current Ratio...............................................50 Acid Test..50 Quick Asset Ratio.52 Inventory Turnover...53

Profitability Ratios...57
Gross Profit Margin....57 Operating Profit Margin...58 Net Profit Margin....59 Asset Turnover.60 Return on Assets.61 Return on Equity.62 Debt to Equity..64 Times Interest Earned.65 Debt Service Margin.66

Capital Structure Ratios..63

IGR/SGR Ratios67 Forecasting Financial Statements..70

Income Statement....70 Balance Sheet.72 Statement of Cash Flows..75

Cost of Capital Estimation.76 WACC estimation....78

Valuation analysis.79

Method of comparables80 Intrinsic Value Models.85 Discounted Dividends Model.85 Free Cash Flow.87 5 Residual Income..88 Long Run Residual Income...90 Abnormal Earnings Growth...91

APPENDIX.92
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Executive Summary
Investment Recommendation: Overvalued, Sell 6-1-07 DG----NYSE (6/1/07) $21.63 EPS Forecast 52 Week Range $12.10-$21.85 2008 2009 2010 2011 2012 Revenue (2/2/07) $9,169,822 .44 .46 .48 .50 .55 Market Capitalization $6.86 Bill Shares Outstanding 314.88 Mill Ratio comp. DG DLTR FDO 3-Month Avg. Daily Trading Volume: Trailing P/E 9.53 22.19 22.75 Institutional Ownership 66% Forward P/E 7.62 17.78 18.98 Book Value per Share $5.706 PEG .065 1.27 1.61 ROE: 20% P/B 11.8 3.87 3.95 ROA: 12% Cost of Capital Est. R2 Beta Ke Valuation Estimates: 3-Month .19 1.19 Actual Price (6/1/07): $21.63 6-Month .19 1.19 Trailing P/E $9.57 2-Year .19 1.19 Forward P/E $7.80 5-Year .19 1.19 PEG $2.92 10-Year .18 1.18 P/B $54.00 P/EBITDA $28.24 Ke 12.09% P/FCF $123.39 Kd 5.19% EV/EBITDA $3.54 WACC 10.99% Altman Z-Score Intrinsic Valuations Actual 2003 2004 2005 2006 2007 Discounted Dividend $18.40 7.48 7.88 7.74 6.43 7.33 Free Cash $29.71 Residual Income $3.22 Revised Z-Score 2007: 2.847 LR ROE $7.21 AEG $8.79

Recommendation: Sell-Overvalued
Industry Analysis
Dollar General was founded in Scottsville, Kentucky in 1939 and was originally called J.L. Turner and Son Wholesale, then Turners Department Store, and then in 1955 it was converted to Dollar General and did not sell any item over $1. Dollar General was the originator of the dollar store concept and in 1968 it became a publicly traded company. Dollar General is a Fortune 500

company and the leader in the dollar store segment, with more than 8,000 stores and $9.2 billion in fiscal 2006 sales (www.dollargeneral.com). Dollar General is in the discount retail store industry and focuses on cost leadership. Its direct competitors are Family Dollar Stores, Freds Inc., and Dollar Tree. In this industry, maintaining low costs are crucial to generating profits, since the merchandise is already being sold at a discount and there is such high competition between companies. The competition is high due to the threat of substitute products: the products being sold are extremely similar, if not identical and pose no switching costs to customers. 8

Accounting Analysis

A major part of analyzing and valuing a firm is analyzing its methods of accounting. The information needed to do this can be found in the companys annual 10-K report. First the key accounting policies are analyzed to ensure that they correspond with the key success factors as defined by the five forces model. Then the degree of flexibility allowed by GAAP is determined, as well as the actual accounting strategy used by the firm. The quality of disclosure is how transparent the companys reports are and how believable their numbers are and is determined though screening ratios. These ratios alert us of any red flags in their accounting, and finally any distortions found are corrected to show the company more accurately. After our analysis, the only area in which Dollar General uses flexibility is in the reporting of leases, which is allowed by GAAP, but greatly alters their financial statements. While the footnotes were very clear in disclosing information, the consolidation of the financial statements makes it difficult to actually see what they are disclosing. After computing all of the revenue and expense manipulation ratios we did not find any red flags so the only distortion to undo was the reporting of the leases. 9

Ratio Analysis, Forecast Financials, & Cost of Capital Estimation

Ratio analysis is done to evaluate a company and to find out how it ranks with its competitors. There are three sets of ratios used in this part of the analysis; liquidity ratios, profitability ratios, and capital structure ratios. All the information needed to compute these can be found in a companys financial statements. In our analysis of the past five years, Dollar General has performed about average with the industry and in a few cases has out-performed the industry. Once these ratios have been calculated they can be used to forecast the companys future performance. By using the CAPM model, a Beta for the company can be estimated; then using the estimated Beta, the companies estimated cost of equity can be determined through regression analysis. Finally the estimated cost of equity can be computed by using the WACC formula.

Valuations

The main focus for valuation models are to show whether the companies estimated value is worth what the market implies. To derive such prices, you must estimate the firms cost of capital and equity, the growth rate, and the WACC and use them to determine how well the companys stock is priced. There are five different valuation models the discounted dividends, free cash flows, residual income, long-run residual income, and the abnormal growth earnings. 10 These models use different factors in deriving the estimated share price, in which some are more accurate than others. We began with the method of comparables, which uses the current financials of Dollar General and also the financials of industry competitors. This method includes using the P/B ratio, PEG ratio, DPS, and trailing/forecasted P/E ratio. We believe this is a good benchmark to where firms should stand when compared to the industry. For our valuation models, we based our valuations using our ten year forecasted financials. The models indicated that Dollar General is highly overvalued compared to our intrinsic valuations. The free cash flow model shows that Dollar General is undervalued; we believe this valuation is doubtful based on the uncertainty of our forecasted cash flow. After using all five models, our overall decision is that Dollar General is highly overvalued and investors should sell. 11

Overview of Dollar General

Dollar General is in the discount retail store industry selling common household necessities, such as cleaning supplies, health and beauty aids, basic food items, some clothing, and seasonal products. The target market of this corporation is people who generally have lower, middle and fixed incomes. Dollar General started out as J.L. Turner & Son, in 1939 as a wholesale business in Scottsville, Ky. The company coined the dollar store concept in 1955 opening retail stores which boosted the companys sales. In 1968 the company went public and changed its name to Dollar General. Today, the corporate office is located in Goodlettsville, TN. (www.dollargeneral.com) Sales volume and growth are very important factors for success in the discount retail industry. As shown below, sales for the industry has been rising each year for the past five years with Dollar General leading the way. Sales Volume *All numbers in thousands. (www.edgarscan.com) * 2002 2003 2004 2005 2006 Dollar General $6,100,404 $6,871,992 $7,660,927 $8,582,237 $9,169,822 Dollar Tree Stores, Inc. $2,357,836 $2,799,872 $3,126,000 $3,393,900 $3,969,400 Family Dollar

Stores, Inc. $1,108,637 $1,244,683 $1,380,245 $1,511,457 $1,600,264 Freds, Inc. $1,103,418 $1,302,650 $1,441,781 $1,589,342 $1,767,239 12 While Dollar Generals sales have exceeded their competition by far, their net income decreased this past year while the competitions rose. This is mainly due to the fact that Dollar Generals general expenses rose and interest income decreased. Industry Net Income *All numbers in thousands. Dollar Generals Stock is currently selling for $21.63 and there are 314,788,000 outstanding shares giving it a market capitalization of $6,808,864,440. While it has far more outstanding shares than its competitors, they are selling at a lower price. In the past year Dollar Generals price per share has remained relatively constant while its competitions prices have been rising. (www.nyse.com). * 2002 2003 2004 2005 2006 Dollar General $262,351 $299,002 $344,190 $350,155 $137,943 Dollar Tree Stores, Inc. $145,219 $177,583 $180,300 $173,900 $192,000 Family Dollar Stores, Inc. $57,478 $64,452 $55,355 $51,389 $54,124 Freds, Inc. $27,491 $32,795 $27,952 $27,952 $26,746 13

Average Stock Prices 2003-2007

05 10 15 20 25 30 35 2003 2004 2005 2006 2007 Year Price FRED FDO DLTR DG Within the past year, stock prices have been on the rise after hitting the low of 13.42 which is the lowest it has been in two years. http://moneycentral.msn.com In comparison to its competitors, Dollar Generals stock is outperforming

its competitors this year after prices fell in the third quarter last year. 14

THE FIVE FORCES MODEL

The five forces model is an excellent tool used to analyze the industry in which the firm is competing in. It helps us see the type of industry the firm is competing in, what characteristics are associated with the type of industry, and also identify what types of things the firm can do to stay a head of the competition. The five forces model includes: Rivalry among existing firms, Threats of new entrants, threat of substitute products and bargaining power of buyers and suppliers. These forces assess the degree of competition and the marketing power of buyers and suppliers. We will use the five forces model to evaluate the industry as a whole. After briefly explaining each segment of the five forces model, the model will be put to use by developing a value chain analysis. After the value chain analysis we will use the complete information to compare Dollar General with the rest of the industry. Cost Leadership Industry Rivalry among Existing firms Threats of new Entrants Threats of substitute products Bargaining power of buyers Bargaining power of suppliers Very High Low High Moderate Moderate

Rivalry among Existing Firms

Dollar General is in the discount retail merchandise industry, which is highly competitive with respect to price, store location, merchandise quality, instock consistency and customer service. Since the discount retail industry is a highly concentrated industry they strive to provide merchandise at low prices, thus it is necessary to keep prices as close to marginal cost as possible. 15 Industry Growth A company striving to make it in this industry has to come up with innovative ways to grow. Most of the firms competing in this industry have found a niche in small towns because of the low and low-middle class population. In doing so, they have experienced a rapid expansion and in turn have increased

their number of stores. Another element encouraging growth is the low every day prices characterized by the industry. As a result of the low prices they are able to cut costs and expand in different areas, like offering a new line of products or even increasing number of stores. Other firms in this industry have invested in advertising, by inserting circulars in the newspapers and reaching out to different customers who dont necessarily shop at a dollar store. Concentration Concentration plays a very big role in price setting. The more competitors in an industry the lower concentrated the industry is which creates price wars. Dollar Generals main competitors include: Family Dollar, Dollar Tree, Freds and 99 Cents Only. The industry is characterized by providing the every day low prices and still making a profit by having a low cost structure and relatively low assortment of products. 16 Market Percentage 2002
40% 17% 31% 7% 5% Dollar General Dollar Tree Family Dollar Fred's 99 cents

2003
47% 1% 37% 9% 6% Dollar General Dollar Tree Family Dollar Fred's 99 cents

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2004 40% 16% 31% 8% 5% Dollar General Dollar Tree Family Dollar Fred's 99 cents
2005 42% 17% 32% 8% 1% Dollar General Dollar Tree Family Dollar Fred's

99 cents

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2006 40% 16% 31% 8% 5% Dollar General Dollar Tree Family Dollar Fred's 99 cents

Differentiation and switching costs The discount retail industry has no differentiation cost because it is a cost leadership competitive Industry. Switching cost would be low because our merchandise is easily liquidated. It would take very little to get rid of the merchandise without losing money and switching to another industry. Scale economies and fixed/variable costs The price of the merchandise depends on how a company handles operational costs. Dollar General emphasizes aggressive management of its overhead cost structure. Additionally, they seek to locate stores in neighborhoods where rental and operating costs are relatively low. Individual Dollar General Store leases vary in their terms, rental provisions, and expiration 19 dates. Majority of the leases are low-cost and short-term ranging from three to five years. Family Dollar leases 5719 of their stores and only owns 489; this indicates that they have high fixed costs. The 99 cents only store own 37 stores and lease 105 store which again shows they have high fixed costs. The level of fixed cost plays a role in the growth of a company in this industry. If the fixed costs are too high then expansion is going to be slow. Family Dollar has 350 stores opened in 2006. The 99 cents only store has only 19 store opening this year. Dollar General has introduced control in fixed cost which is supported by the 300 stores they plan to open this year, plus remodeling 300 other stores. In such an industry, firms must generate large inventory turnover for the fixed cost to cover variable costs. In conclusion, if a firm wants to be successful in this industry they have to make sure that they do not have too many fixed costs, because this slows down growth. If they have a lot of fixed costs then they need to make sure that they generate large inventory turnover to cover the variable costs. Excess Capacity and Exit Barriers Excess capacity exists if the customer demand exceeds supply. In the discount retail industry, supply is always greater than demand because of the amount of competition and ease of access. Same-store sales are one way to monitor just how much sales a firm is getting. Same-store sales measure the increase or decrease in sales for the stores that have been open for more than one year. This helps a firm know just how well they are doing in comparison to the industry. There are high exit barriers in the discount retail industry mainly

because it would be costly and time consuming to liquidate merchandise or break lease agreements. For these reasons, the industry requires lower cost and increases rivalry among existing firms. The discount retail industry is characterized by high exit barriers mainly due to cost of liquidation. Same-store sales are an important measure for firms 20 to use so they can see just how much they are selling and how much inventory they have left, thus avoid tying up their resources in idol inventory.

THREAT OF NEW ENTRANTS

The potential for earning high profits in an industry will attract new entrants to an industry. Easily accessible industries force existing firms to compete not only with the new entrant but also amongst other firms. There are many barriers for new entrants in the discount retail industry. New entrants must rise above large economies of scale that exist within established firms. Also, suppliers will be difficult to find in the discount retail business mainly because of profitability sought by suppliers. There are few legal barriers to be faced; new firms will face some legal discretion just like in any industry. There is the possibility for entrance of new firms but there are barriers to be faced. Economies of Scale When entering into a specific industry, economies of scale play a major role. New entrants will initially suffer from a cost disadvantage in competing with well established firms. New entrants do not have the capital and resources to compete on such a level. Dollar General and Family Dollar Stores are the two largest firms in this industry and have the upper-hand on suppliers and distribution access to their stores. This advantage poses high economies of scale allowing most of the firms in the industry to offer low prices for their customers. The diagram below shows the level of assets possessed by the existing firms in the industry. Thus new entrants would have to acquire the minimum capital needed to enter the industry. 21 Total Assets 0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 2005 2006 2007 Dollar General Dollar Tree Family Dollar Fred's Inc 99 Cents Only

Channels of Distribution and Relationships It is imperative for a firm to have a proficient channel of distribution and keep good relations with the supplier in order to be cost efficient. The discount retail industry is cost driven therefore making it essential for the company to be efficient. It is difficult for new entrants to distribute their goods from suppliers without the right system. Dollar General has nine distribution centers (also used as warehouse space) of which they lease three but own the other six and has their own trucking system to deliver goods to their stores. Family Dollar has nine distributing centers, but they do not have enough trucks to distribute their merchandise. 86% of their merchandise was distributed by external carriers in 2006. In order for Family Dollar to manage this, they have a good relationship with their carriers that lead to discounts. The 99 Cents Only lease trucks and also transport by rail. 22 Legal Barriers There are no direct legal barriers in the discount retail industry. Legal barriers exist when importing goods from other countries therefore making it costly in terms of trained personnel in international trade policies. Dollar General directly imports 14% of their goods and Dollar Tree imports 35%-40% of their goods. Companies need to be aware of certain items such as; import laws, currency exchange, and foreign business operations. New entrants have a tough hurdle to overcome when it comes to legal barriers. With most of their products supplied by companies abroad, it would be costly and difficult for a new entrant to compete to get the same supplier or even try to lobby for the same prices.

THREAT OF SUBSTITUTE PRODUCTS

The discount retail industry is a highly competitive industry with five direct competitors and certain other relative competitors like Wal-mart and Target. Customers are therefore very price sensitive. Threat of substitute products is low in the discount retail industry because the products offered are generally the same across the board. In the discount retail industry most of the firms have the same suppliers therefore the products are the same. Buyers willingness to switch The discount retail industry is very price conscious, therefore most the players in the industry compete in those terms. Also, since the products in the industry are the same, customers are drawn to picking the firm with the lowest price, therefore the customers switching cost is very high. 23

Bargaining Power

In the Following sections, bargaining power will be discussed relative to the buyers and suppliers of the market. The industry will be examined as a lowcost, highly competitive market. The five factor model guidelines will be used in assessing the industry. Topics that will be discussed include switching cost, product cost and quality, number of buyers, and volume per buyer.

Information will be given on how a company should compete in order to be effective in a highly competitive industry. The guidelines and information will help value the companies in the industry. The next two sections will give an idea of what the industry requires of buyers and sellers. Bargaining power of the Customer In such a highly competitive market, the customers have a rather large bargaining power over the companies in the industry. It is easy for customers to switch from store to store depending on the relative prices of each. The switching cost is merely the price of gas to drive or time to walk from one store to the next. The customers of the discount retail industry have a some what higher volume per purchase because the stores are catered to be a one stop shop for the lower/ lower middle class customer. For this reason, firms in this particular retail market have incentive to keep prices as low as possible because of the bargaining power of the customer. Switching Cost Switching cost of the customer is a large reason why the customer has bargaining power. A customer can easily switch from one low price store to another depending on how cheap the stores products are. The price sensitivity of the buyer is relatively high because they have limited financial means. Each of the companies in the industry carry the same line of products, and the customers will look for the best prices among each. For the reasons above, it is highly 24 important where a store is located. Most companies will situate a store in or very near low-income neighborhoods. Product Cost and Quality The particular industry does not focus as much on the product quality as it does on the price of the product. The companies in this industry will carry substitute products that are lower quality rather then name brand items in more expensive stores. The industry has to focus on the cost rather then quality because the customers demand the cheapest product possible. Number of Buyers The number of buyers in the industry is the lower middle and lower income consumers in the industry area. The discount retail industry is affected by every customer. The number of customers and amount bought determines the profitability of the company. In essence, the customer has more bargaining power because the stores survival depends on the number of customers. It is very important for companies to keep prices low to remain attractive. Volume per Buyer The volume of products bought by a customer in the discount retail industry can vary from a few items to several. Most of the customers of this industry use the stores as a one stop shop. Once again, each customer matters. After evaluating each segment of bargaining power of the buyer, we concluded that the bargaining power of the customers for the discount retail industry is relatively high.

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Bargaining Power of the Suppliers

In contrast to the bargaining power of the customer, the bargaining power of the suppliers is relatively low. The low switching costs, number of companies, and the number of substitute suppliers are factors that give very low bargaining power to the suppliers. The companies in the discount retail industry are very price sensitive because it caters to the low-income customer. The suppliers of products have to sell at the right price because companies are trying to keep the lowest cost possible. Switching Cost The switching cost is relatively low among suppliers. It is important for a company in this industry to minimize cost as much as possible. The large number of suppliers that are available makes it easy for companies to switch to suppliers that have the lower costs. Suppliers have to compete with one another to supply to the companies in the industry. Their bargaining power is very low because the stores dictate who they will choose and it will always be the lowest cost supplier. Product Cost and Quality Suppliers have to focus on minimizing costs. Product quality is not at the forefront t because companies are not shopping for quality products, but they are looking for low cost products. The suppliers have no choice but to focus on cutting costs. Number of Suppliers The number of suppliers in the discount retail industry is very large. The large number of supplier decreases the bargaining power of the supplier because of the number of alternatives for the customers. Each supplier has no choice, but to compete with each other and whoever is able to achieve the lowest price gets the deal. 26 Volume per Supplier The volume of purchases by the companies is moderate. The suppliers need to keep cost low in order for companies to consider them as a supplier. If the supplier cant supply the products at the right price set by the companies the company will look for other producers. The volume at which the companies will purchase at is more incentive for suppliers to keep cost low. In conclusion, the suppliers in the industry need to maintain low costs because of the bargaining power in the hands of the company. The number of suppliers available and the ease of switching from one to the other affect how much bargaining power each supplier is able to have; therefore, the bargaining power of suppliers is low. Lastly, the five forces model is a tool used to value an industry and see how attractive it is. The model is divided into two categories, the degree of actual and potential competition, which talks about how the firms in the industry compete with each other and the strategies used in the industry in order to stay competitive. The second part is the bargaining power in the input and output

markets, which talks about the bargaining power of suppliers and buyers. It focuses on the things they do in order to stay ahead of the competition.

Value Chain Analysis

The value chain analysis discusses important strategies that a company needs to utilize in order to be a cost leader in the industry. The following paragraphs will go through each strategy and analyze effective ways a company can pursue in order to keep costs low. The following analysis will present information on how a discount retail company should compete in a highly competitive industry. After the value chain analysis is complete we will use the information to evaluate Dollar Generals performance in the discount retail industry. 27 Dollar General resides in a highly competitive discount retail industry. Each company competes to provide basic commodities and service at a low price. In order to be successful, each competitor has adopted the business strategy of cost leadership. By implementing this strategy successfully, companies will be able to earn profits and gain greater market share. Efficient production In order for a company to be a cost leader in the discount retail industry, the company has to be efficient and strive to have low operational costs. Improving Technology helps to cut cost and increase efficiency with systems like inventory management tools and supply chain systems (Dollar General 10k). Another way to be efficient is by maximizing trailer loads in order to cut down on the number of trips to be made and increase efficiency (family Dollar 10k) Simpler Product Design Since this is a discount retail industry, quality is not as an important factor therefore a company can sacrifice on using high quality raw materials and go for the generic products that cost much less. The companies need to use low cost products many of which rely on the supplier they choose. Efficient companies are able to get semi-decent quality products at a very low price. Lower Input costs A company in the discount retail industry needs to keep input cost at a minimum. Companies can reduce the amount of input costs by managing leases, buildings, and warehouse in an efficient manner. Low-cost distribution Lower cost distribution is also very imperative in cutting costs. If a company has to hire a transporting company, warehouse space and labor that go along with it, they incur unnecessary costs. This factor alone makes it very 28 difficult for new entrants to survive in the industry. The company needs to minimize these cost by using efficient, low-price means of distribution. Minimal Brand Image cost Companies in the discount retail industry need to have very little expenses in brand images. A company that spent money to keep its image up would be

using unnecessary cost. In order for a company to be a cost leader, it must minimize its unnecessary expenses. Tight cost control The discount retail industry mainly deals with the same types of products therefore making it important for a company to strive to be a price leader. Since the industry deals in discounted products you can only lower the price so much, thus the company has to focus of having lower operational cost in order to be able to have the everyday low prices. Having long relationships with suppliers, is a good way of cutting cost because it enables a company to have a steady supply of merchandise at a discount. This not only makes it hard for new entrants, but it also cuts costs.

Firm Competitive Advantage Analysis

In this section, we will discuss how Dollar General has performed using the value chain analysis in the previous section. Each section of the value chain presented above will be presented relative to our company. We will discuss how the company has performed historically, currently, and how they are projected to perform in the future. The competitive advantage analysis is important because it shows how well Dollar General is utilizing cost leadership in a very competitive industry. Each Section below will discuss important information that will help value the company relative to other companies in the industry. 29 Efficient production Dollar General has done a decent job to utilize the cost leadership strategies. It has focused on efficient low cost production and distribution. They have their own warehouse and trucks to supply stores to minimize transportation costs. Dollar General will only use suppliers that can maintain a low cost on products and delivery. They have diversified their supplier chain to minimize costs which is due to 14% coming from Proctor & Gamble, 16% from imports, and the maintaining from different suppliers. They have located every store in cities that are 20,000 or less populated to cater to their target market. Currently, Dollar General is trying to improve the efficiency of its stores. They are closing a few stores in less productive areas and spending money to remodel, advertise and develop a more efficient means of distribution. They hope to improve the quality of existing stores to maintain there slightly higher position in the industry. Simpler product design As a leader in the industry, Dollar General provides basic commodities at a low price. A sacrifice in the quality must be made to achieve these low prices. As a result, products that are offered do not carry a brand image and has no research and development costs. This is a key to be competitive in the industry and Dollar General will continue to provide simple product designs throughout the year to accommodate the demand for low cost merchandise Lower Input Costs

Dollar general historically has minimized input cost spending very little on capital improvement costs. They have tried to minimize the cost of owning buildings by leasing out most of their buildings. They have had a system that has focused on minimizing input-costs. 30 Currently, Dollar general has spent more money trying to remodel worn down buildings and increase sales space. They have also invested a lot of money into improving their distribution system to increase efficiency. They have also incurred costs to shut down non-producing stores. Dollar General hopes that these improvements will increase sales and lower costs in the future. We believe that these expenses will have a negative effect on the companys value currently, but could improve the companys value in the future. Low-cost Distribution Dollar General owns six of there nine distribution centers across the U.S. and have their own trucking service. This helps minimize the cost of contracting to other trucking companies. The distribution centers, being located in central hub areas, cut costs of transportation to Dollar General stores. 99 Cents Only lease to trucking companies which adds to cost. We believe because they are cutting distribution costs, they have the upper-hand against the competitors in the industry. Minimal Brand Image Cost Dollar General owns several trademarks pertaining to their company and subsidiaries. Brand image is not a high cost for Dollar General; they invest when needed in their image to protect their identity in the industry. Tight Cost Control As a leader in the discount retail industry, Dollar General has to continually focus on improving their tight cost controls. This will help sustain low prices that drive the success of the stores. Recent improvements in the point of sale system allow the store to accept gift cards which will bring in a new source of revenue. An additional upgrade of software applications was added to monitor inventory in each store. This allows management to efficiently manage 31 their in store stocks and improve turnover. These investments made will help Dollar General operate their stores more efficiently and will in turn reduce their operating costs. Conclusion In our analysis, we have concluded that Dollar General is doing a decent job in utilizing cost leadership strategies. They are striving to be the cost leader in their industry. They have taken on many projects to improve quality, efficiency, and production that could help lower overall costs in the future. The company has also spent only what it needs on brand imaging keeping costs low. Dollar General owns most of there distribution centers and trucks minimizing contracting fees.

We believe that Dollar General recent costs to improve their stores and improve production may decrease the value of the firm in the short-run compared to competitors; however, the improvements to the stores quality and efficiency could improve the company overall in the future. Other then the recent costs to improve current stores, Dollar general is utilizing effective cost leadership strategies. 32

Accounting analysis

Within a companys financial reports lies crucial information to determine the valuation of its performance. An accounting analysis is used to assess the financial disclosures and conclude if its accounting practices support the structure of the industry in which the company resides in. This examination is important because the financial reports released have managerial estimates and judgments that affect the outcome. The first step is to identify the key accounting policies of the company. Next, the analyst has to assess the degree of potential accounting flexibility, or how able the company is to manipulate numbers and still follow the rules outlined by GAAP. An evaluation of the actual accounting strategy is performed next to decide how conservatively or aggressively the flexibility is used to manipulate financial reports. The next step is to review the quality of information disclosed in the statements. From the evaluation, there could be some red flags that signal discrepancies in the reported information. The figures need further investigation to determine its validity. The last step in the analysis involves undoing the accounting distortions. The following is the assessment of Dollar Generals accounting practices. 33

Key Accounting Policies

Dollar Generals main Key Success Factors focuses on cost leadership. Dollar General uses slightly aggressive accounting policies and is only partially clear in stating how they record transactions in their footnotes; however the only balance sheets they give are consolidated so you cannot actually see the individual events being recorded. Dollar General record vendors rebates as a reduction of merchandise purchases costs and are recognized in the statement of operations at the time the goods are sold (Dollar General 10-K). This reduces their overall costs and allocates the extra cash to the correct account. Dollar General does not have any Goodwill recorded, which can be used to inflate a companys value since it is an intangible asset. Dollar General records store opening costs as expenses as they occur (Dollar General 10-K p56) rather than capitalizing them. This is the appropriate and honest way to account for these costs. Another way Dollar General maintains their cost leadership is through the reporting of building leases. In terms of the types of leases Dollar General has,

they have both operating and capital leases. Dollar General leases the majority of its stores on a short term of 3-5 years. These leases include multiple renewing options for the managers to decide on a basis of performance and sales. In addition, there are store that are built-to-suit where the leases range from 7-10 years. Among all the stores that Dollar General leases, half are operating on a contingent rent based on sales. If a store is performing well, the 34 likelihood of it renewing its lease is high. This conditional rent expense is recognized when sales goals are met or probable. For the remaining stores, rent expense is recognized on a straight line basis over the term of the lease. Also, if it is stated in the lease that rent will increase annually at a fixed rate, rent expense is recognized on a straight line basis while the increased amount will be recorded as deferred rent. Another accounting strategy that Dollar General uses to its benefit is to record tenant allowances as deferred incentive rent. This in turn can be amortized to reduce rent expense over the term of the lease. Industry Inventory 2002-2006
$0 $200,000,000 $400,000,000 $600,000,000 $800,000,000 $1,000,000,000 $1,200,000,000 $1,400,000,000 $1,600,000,000 2002 2003 2004 2005 2006 Dollar General Family Dollar, Inc. Dollar Tree, Inc. Fred's, Inc.

35

Degrees of accounting flexibility

Managers at Dollar General may have latitude with their reporting methods within their financial statements, but they must comply with industry standards of GAAP. This set of regulations is the framework for which all companies must use in the preparation of financial statements. Accounting manipulation within the guidelines of GAAP may produce or conceal important information that would work in favor the company. Dollar General uses this flexibility in reporting their key accounting policies of leases and vendor rebates. As previously stated, Dollar General accounts for its leases under both capital and operating. The accounting flexibility in balancing between these two methods allows them to determine how much is disclosed on their financial statements from operations. The benefit of operating leases is that it allows Dollar General to report its lease expenses as an operating expense leaving it off the balance sheet. This in turns reduces the liability of the company. Conversely, the amounts that are reported under capital leases are recognized immediately on the balance sheet. The following table shows how the leases are currently

reported for Dollar General. They are discounted at an effective interest rate of 6.7%. 36 Future Minimum Payments of leases *In thousands Capital Leases * Operating Leases * 2007 7,658 304,567 2008 5,440 254,087 2009 2,082 206,369 2010 599 169,454 2011 599 139,841 Thereafter 7,036 415,263 Total minimum payments 23,414 1,489,581 Discount rate 6.7% (Dollar General 2006 10-K) It is evident that the majority of Dollar Generals leasing costs are operating rather than capital leases. The large amount of operating leases is crucial to the stores success in the discount retail industry. A stores ability to bring in revenues and earn profits is the key to remain in business. The flexibility in the terms of the lease allows managers to assess the profits earned for a store and to determine if they can afford to remain in business. The ability of Dollar General to spend a large amount of money on operating leases allows them to keep that same amount off the balance sheet as a liability. This reduces the amount of debt reported on the balance sheet working in favor of the company. Another method of accounting flexibility shown by Dollar General is the way vendor rebates are handled on the financial statements. Vendor rebates received are accounted for as a reduction in the purchase cost of the merchandise. This is recognized in the statement of operations at time the 37 commodities are sold. Cash considerations from the vendor may in turn offset some general, selling and administrative (GS&A) expenses related to the sale of the merchandise. Depending on the amount of rebates Dollar General realizes, it reduces operating expenses showing greater income. This rebate is limited and will only offset the costs associated with the GS&A expenses incurred of the merchandise. Consequently, this is an incentive for Dollar General to claim as many vendor rebates as they can. However, while the footnotes are very clear on how they do this the actual numbers are not given on the balance sheet; therefore, it is unclear just how much this affects their financials.

Accounting Strategy

Dollar General uses slightly aggressive methods when reporting their financials. Dollar General disclosed quiet a bit of information in their footnotes, but supporting data was hard to interpret. We feel that their slightly aggressive accounting policies made it difficult to go through their financial statements. Dollar General has both operating and capital leases. The majority of

capital leases have terms between 3 to 5 years with renewable options. There are built-to-suit arrangements with landlords that have terms of 7 to 10 year and multiple renewal options on some of the leases. Operating leases are treated as rent expense rather than being liabilities therefore it does not give a true picture of total liabilities on the balance sheet. Improvements of leased properties are 38 amortized over the shorter of the life of the applicable lease term or the estimated useful life of the asset (Dollar General 10k) Dollar Tree and 99 Cents Only also have similar accounting strategies, concluding that this could be an industry trend. The recording of depreciation, benefit, and goodwill are a few of the minor things Dollar General has done to stay a head of the competition in a cost leadership industry. Dollar General depreciates property, plant, and equipment using the straight-line method. A benefit to using the straight-line method is at the end of the life term of the asset the company pays the salvage value of the asset opposed to the fair value, decreasing the expenses related to these assets and further helping the bottom line. Employee benefit plans are expensed on a year to year basis rather than being liabilities to the firm. Dollar General does not have any goodwill on the books which we consider a very conservative accounting strategy. This indicates that they do not inflate their numbers for investors. Since Dollar General is in a low concentrated industry, they strive to provide merchandise at everyday low prices thus it is necessary to keep prices as close to marginal cost as possible. Dollar General has achieved this by categorizing their products into four distinct areas; highly consumable, home products, seasonal, and basic clothing. This has made it easy for management to track where most sales come from and improve where they need to, as shown below in the graph. 39

Product Sales

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 2006 2005 2004 Highly consumable

Home products Seasonal Basic Clothing Quality of Disclosure Qualitative

The quality of disclosure is very important to investors and analysts. The 10K is usually the best source of information when looking at a companys well being. However not many companys do a good job in disclosing a lot of important information in their 10K. Dollar General does a good job in disclosing a lot of important information in their 10K. They not only focus on showing only the elements in which they excel in but also areas that they are not doing too well in. For example The gross 40 profit rate declined in 2006 from 28.7% to 25.8%. They farther go on to explain the reason for the decline which resulted due to significant increase in markdowns activity as a percentage of sales, and store closing initiatives. The only downfall is that they do not disclose how they will go about correcting the problem; we thought that would be critical information for investors to know, otherwise they may think that gross profit will continue to fall. Dollar Generals 10K is loaded with good information. They go into detail talking about the company performance measures, the results of operations. This managers overview helps an investor know exactly how the firm is doing without doing too much research. The footnotes on the financial statements are informative and explain what on the financial statements. For example it states how the capital leases and operating leases are handled and what percentage they cover. In February 2006 the gross amount of property and equipment recorded was 85.1million and 150.2 million as of February 2007. This gives a true picture of the fixed assets that Dollar General has.

Quantitative
41 The measure of the quantitative quality of disclosure involves two sets of ratios, revenue diagnostics and expense diagnostics. We will use the data from the ratios in our valuation of the firm. The data we collect from this section will indicate how well Dollar General has reported their financial information and potentially identify any red flags.

Sales Manipulation Diagnostics

We calculated five core sales manipulation or revenue diagnostics. We found these by dividing a companys net sales by the following denominators: cash from sales, net accounts receivable, unearned revenues, warranty liabilities, and inventory. When analyzing a company, the ratios are calculated over time and compared to those of the competitors in the same industry. The ratios

indicate how well the company is reporting their revenues. 42 Net Sales/Cash from Sales
0 0.2 0.4 0.6 0.8 1 1.2 Dollar General 1 1 1 1 1 Dollar Tree 1 1 1 1 1 Family Dollar 1 1 1 1 1 Fred's Inc. 1 1 1 1 1 2002 2003 2004 2005 2006

Net sales/Cash from sales

The discount retail industry is cash to sales basis industry. A cash to sale industry is one in which every sale is accompanied by payment, therefore deferred payments do not exist. Thus, the ratio of net sales/ cash from sales is 1 all across the board.

Net sales/Net accounts receivable

Since the discount retail industry is cash to sale industry they do not have any account receivables, thus the ratio does not affect the industry. 43

Net sales/Unearned revenues

Unearned revenue is when a company offers a service or product and does not receive immediate payment until later. The discount retail industry does not have credit sales because everything is on a cash to sale basis, therefore this ratio does not apply to the industry.

Net sales/Warranty liabilities

Warranty is when a company guarantees their products of by offering to replace or repair the product if something goes wrong within a specified amount of time. So a company that has warranty liabilities would have high sales but low revenues. The discount retail industry does not offer warranties on their products so again this ratio does not apply to the industry. Net Sales/Inventory
0 2 4 6 8 Dollar General 5.43 5.94 5.57 5.82 6.4 Dollar Tree 5.37 5.33 5.08 5.89 6.56 Family Dollar 5.43 5.56 5.39 4.42 6.16 Fred's Inc. 5.7 5.43 5.24 5.23 5.79 2002 2003 2004 2005 2006

44

Net Sales/Inventory

The net sales/ inventory ratio is important because it tells us the amount

of inventory we have in relation to our sales. It asks the question; do reported sales and inventory match each other in a believable way? If this number starts increasing rapidly and/or unexplained it raises a red flag because it would imply that while sales are growing, inventory is decreasing. If it is increasing like this, the company must be recording things wrong, or perhaps channel stuffing. We have found the industry as a whole to be pretty consistent the past five years and have not found any potential red flags for Dollar General.

Core Expense Manipulation Diagnostics

There are six core expense manipulation diagnostics. These ratios are found in a variety of ways, but they all relate to a companys expenses and are also used to identify potential red flags. 45 Asset Turnover (sales/assets)
0 1 2 3 4 Dollar General 2.61 2.62 2.7 2.88 3.02 Dollar Tree 1.81 1.86 1.74 1.89 2.12 Family Dollar 2.37 2.39 2.37 2.42 2.53 Fred's Inc. 3.19 3.14 3.1 3.19 3.43 2002 2003 2004 2005 2006

Asset Turnover Net Sales/Total Assets

The asset turnover tells us how much sales our assets can generate. If this number begins declining, it implies that sales are decreasing while assets are increasing, we must wonder if the company has the appropriate amount of assets to generate the desired sales. Through off-balance sheet accounting, reporting operating leases, as opposed to capital leases, a company can show fewer assets on the balance sheet and in turn have a higher asset turnover ratio. Overall the industry is quite consistent and Dollar General has remained consistent with the industry standards and show no potential red flags. 46 CFFO/OI
-1.00 0.00 1.00 2.00 3.00 Dollar General 0.93 1.01 0.70 0.98 1.63 Dollar Tree 2.77 0.83 0.94 1.28 1.33 Family Dollar 0.23 -0.33 -0.11 0.44 0.52 Fred's Inc. 1.02 0.72 0.54 1.21 0.86 2002 2003 2004 2005 2006

Changes in CFFO/OI

This ratio is found by dividing the cash flow from operations by the operating income and tells us whether or not the income is being supported by the cash flows. If this number is dropping without explanation it raises a red flag because cash flows cannot be increasing while income decreases. In this

situation, expenses may not be recorded or revenues may be overstated. With the exception of Dollar Tree in 2002, the industry has remained quite consistent. Seeing that Dollar General has remained consistent with the trends and has not fluctuated too much over the past five years there are no potential red flags to investigate. 47 CFFO/NOA
-1 -0.5 0 0.5 1 Dollar General 0.42 0.54 0.36 0.47 0.33 Dollar Tree -0.5 0.38 0.4 0.54 0.58 Family Dollar 0.59 0.36 0.41 0.29 0.42 Fred's Inc. 0.34 0.49 0.28 0.15 0.35 2002 2003 2004 2005 2006

Changes in CFFO/NOA

This ratio is found by dividing the changes in a companys cash flow from operations from the previous year by its net operating assets. If this ratio is dropping without explanation it raises a red flag because in order for this to happen the assets are most likely being overstated to increase a companys value. Overall the industry has remained steady with the exception of Freds Inc., who had a negative cash flow in 2002, but has since recovered. The only concern we have is that Dollar Generals ratio slightly dropped in 2004 and 2006. However, this drop can be explained by an increase in net operating assets due to recent renovations and added equipment, such as freezers. Overall, there are no potential red flags in this area. 48

Accruals/ Changes in Sales-

This ratio is found by taking the total accruals for the year and dividing them by the difference in the sales of the current year and the previous year. Total accruals are found by subtracting the net cash flow from operations from the net income. This measure is a way to measure the returns the company is getting form operating assets.

Pension Expense/ SG&A

Dollar General has a defined contribution plan in place. The defined contribution plan leaves the liability on the hands of the employee and the obligation of the employer is merely a small percent of the plan. They do not need to recognize any Pension Expense through out the year only when it is incurred. No ratios needed to be calculated.

Other Employment Expenses/ SG&A

Other employment expense includes medical insurance and other certain benefit programs. Due to the nature of the discount retail Industry Companys offer little to no benefit packages. Most employees are privately insured. No

Ratios need to be calculated. 49

Identifying Potential Red Flags

The quantitative characteristics of a firms accounting disclosure can be analyzed to signal distortions in the accounting. In this section, we will analyze the discount retail industry and compare Dollar General with the rest of the industry. The main purpose of this section is to find potential deviations from the norm that could potentially distort the companies accounting records. We will be assessing several ratios and evaluating the amount of disclosure Dollar General has presented. Identifying potential distortions in the accounting is important because a clearer view of the company can be presented once the distortions are fixed. The following ratios will help compare and signal any deviations Dollar General may have compared with the rest of the company. * The fact that Freds Inc. fiscal year ends in August while every other company year ends in March or May was taken into consideration in the comparability in our analysis. 50

Undoing Accounting Distortions

Accounting distortions occur when a company unknowingly or knowingly reports numbers that are misleading. This allows the managers to influence the outcome of the financial statements to show better performance. The simplistic nature of the discount retail industry enables Dollar General to report their financials rather straight forward without accounting alterations to show better value. This industry is driven by high volume sales of low cost items. Revenues and profitability determine if store operating leases will be renewed to cut loses. After analyzing Dollar Generals financial statements and determining the level of sales and expense manipulation, we did find a potential red flag from the CFFO/NOA ratio. Dollar Generals expense diagnostics raise a red flag with their accounting reporting. The cash flow from operations to net operating asset ratio shows us the proportion of the operation cash flows from the property, plant, and equipment owned. In comparison to its competitors, the ratio is on average except for 2005 when the ratio dropped for Dollar General. The increase in the net operating assets is a result from the growth of the company in the past years. Dollar General has been acquiring new assets to expand their departments to meet the demand of the discount retail industry. This information was disclosed on the Dollar General 10-K allowing us to match the increase in assets. 51 Dollar General has used accounting flexibility to record a large portion of their leases as operating leases. In the next table we have converted the current operating lease payments into capital leases to show the differences of approximately $1.2 billion in avoided liabilities.

Operating Lease Conversion Capital Leases Operating leases PV Factor PV 2007 $7,658.00 1 $304,567.00 0.937 $285,442.36 2008 $5,440.00 2 $254,087.00 0.878 $223,179.14 2009 $2,082.00 3 $206,369.00 0.823 $169,883.50 2010 $599.00 4 $169,454.00 0.772 $130,735.69 2011 $599.00 5 $139,841.00 0.723 $101,114.26 2012 $1,407.20 6 $83,052.60 0.678 $56,281.64 2013 $1,407.20 7 $83,052.60 0.635 $52,747.55 2014 $1,407.20 8 $83,052.60 0.595 $49,435.38 2015 $1,407.20 9 $83,052.60 0.558 $46,331.19 2016 $1,407.20 10 $83,052.60 0.523 $43,421.92 Reported Capital Leases $23,414.00* Total Operating Leases $1,489,581.00* Total Capital Lease $1,158,572.63* *In Thousands Along with the avoided liabilities, the reporting of operating leases leads to understated expenses. This next table shows the interest expense and depreciation expense being avoided over the next ten years, using the 6.7% rate found in Dollar Generals 10-K. 52 Discount Rate 0.067 Term 10 Payment Interest Principle Straight Line Depreciation 1,158,573 2007 1,073,522 162,675 77,624 85,050 $115,857 2008 982,774 162,675 71,926 90,749 $115,857 2009 885,945 162,675 65,846 96,829 $115,857 2010 782,629 162,675 59,358 103,316 $115,857 2011 672,390 162,675 52,436 110,238 $115,857 2012 554,766 162,675 45,050 117,624 $115,857 2013 429,260 162,675 37,169 125,505 $115,857 2014 295,346 162,675 28,760 133,914 $115,857 2015 152,460 162,675 19,788 142,886 $115,857 2016 0 162,675 10,215 152,460 $115,857 *All Numbers in thousands. **The affects of the capitalization of these leases on the balance sheet can be seen in the

appendix. 53

Financial Analysis

At this part of the valuation, it is important to tie together all the previous analysis. This gives a true sense of how the company is operating in the industry and where it is heading in the future. First we identified the business strategy and the five success factors. This tells us how the company plans to thrive in the discount retail industry. From the accounting analysis, we will be able to determine from past financial statements how the company will fund future growth. To properly forecast the future of Dollar General and assess their development, it is essential to calculate the liquidity, profitability, and capital structure ratios. Liquidity ratios refer to the amount of cash or equivalence on hand for operations. Profitability ratios determine the amount of profits based on operations. Capital structure ratios determine the cost of debt it takes to operate the business. These ratios will help determine how well the company is performing from a business strategy perspective to its competitors. Trend & Cross Sectional Analysis The analyses of a firms financial statements tell about its liquidity, profitability, and capital structure. Know these things when analyzing a firm is important in order to evaluate the firm and its performance. The liquidity ratios tell us how much of the firms assets is cash or cash-equivalents and in turn tell how timely they will be able to meet their current obligations. The profitability ratios tell how profitable a firm is based on its efficiency and rate of return. Finally, the capital structure ratios tell how the firm is financed and how much of their income is being used to pay interest versus how much is being used to pay the principal. 54 Financial Ratio Analysis Several ratios can be performed to evaluate the financial position of a firm. Each ratio illustrates a different aspect of the companys well being for example how quick assets can be converted in to cash to cover liabilities. The ratios can also tell how efficient the company is in the industry. Each ratio will be computed to reflect a 5 year trend of each company. Three main areas that will be focused on in the following section are liquidity ratios, profitability ratios, and capital structure ratios. These ratios will be used to asses Dollar Generals position in the discount retail industry. Each ratio will dissect the financial statements of Dollar General and their competitors. From these ratios, the value of the past performance can be determined as well as trends that can help in forecasting the future trends of the company. Liquidity Ratios Liquidity ratios apply to the amount of cash equivalent assets on hand for a firm and the ability to convert these into funds for future liabilities. The liquidity ratio will be broken down into two different types of ratios. The first two

line items are current and acid test coverage ratios which display a companys ability to cover debt with current assets. The next three ratios are operating efficiency ratios which consist of inventory turnover, receivable turnover, and working capital turnover. The operating efficiency ratios are based on the cause and effect using financial data from both the income statement and the balance sheet. The first sets of ratios we have analyzed are the liquidity ratios and of these the first to discuss is the current ratio. The current ratio is found by dividing a firms current assets by its current liabilities. Current assets are almost all assets besides land, buildings, equipment, and intangibles; and current liabilities are any liabilities that will be due in the next year. This number tells us 55 how many dollars of assets we have for every one dollar of liability. The higher the number this ratio is, the more liquid a firm is, or the greater ability it has to pay off its upcoming obligations. However if this number is too high above the industry standard the firm is most likely not using all their assets efficiently. The lower this number is the more debt the firm has in comparison to its assets, and therefore less able to pay them off. Dollar Generals current ratio over the past five years has remained just below the industry average. Although, when looking at the chart you can see that Dollar Tree has had a much higher ratio than the other firms, and in turn has brought the industry average up. Dollar Generals ratio being lower than the industrys is nothing to be alarmed about, especially since they have constantly had more than one dollar of assets to every one dollar of liabilities. Current Ratio over the past five years Below is the cross sectional analysis showing the trends of Dollar General over the past five years in comparison with the trends of its direct competitors and the industry as a whole. Dollar General started out with the lowest current ratio, but more recently has been just below the industry standard. While Family Dollar started out with a higher ratio than Dollar General, their ratio has been declining and they currently have the lowest ratio in the industry. Freds and Dollar Tree have ratios that remained higher than the industry in the past five years. This could mean they are inefficiently using their assets. Overall Dollar General has the best ratio because it is closest to the industry standard without 2002 2003 2004 2005 2006 Dollar General 1.37 1.99 2.22 2.1 1.89 Family Dollar 1.99 1.94 1.72 1.51 1.44 Dollar Tree 2.88 2.73 3.29 3.19 2.5 Freds 3.27 2.55 2.55 2.76 2.58 56 being too high. The trend with each competitor in the industry appears to be heading towards convergence within the next couple of years. Current Ratio
0 0.5

1 1.5 2 2.5 3 3.5 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree Freds Industry. Average

The second liquidity ratio is the quick asset ratio or acid test. This shows how much cash or cash-equivalents there are for every dollar of liability and is found by dividing the quick assets by the current liabilities. Quick assets are cash and any assets that can be easily converted to cash if need be. Dollar Generals quick asset ratio has been pretty low for the past five years with the exception of 2004 where it peaked. This is similar to the current ratio in that too high a number can equate to inefficient use of assets. Recently Dollar General has remained below the industry average, but has still followed the industrys trends. Acid Test for the past five years 2002 2003 2004 2005 2006 Dollar General 0.23 0.18 0.54 0.33 0.22 Family Dollar 0.41 0.35 0.21 0.16 0.22 Dollar Tree 1.13 0.64 1.08 1.15 0.8 Freds 0.26 0.09 0.04 0.046 .023 57 Below is the cross sectional analysis of Dollar Generals quick ratio as well as its direct competitors and the industrys as a whole. With the exception of Freds, the industry has remained within the range of a dollar over the past five years ($0.16-$1.15). Freds most likely has far too many assets in comparison to the industry, which shows signs of inefficiency. Dollar Tree, Dollar General, and Freds have all followed the industry trend the past five years, while Family Dollar has done just the opposite. Since Freds has such a higher ratio it has brought the industry ratio up; therefore there is no need to be alarmed over Dollar General being slightly lower than the industry. Quick Asset Ratio
0 0.2 0.4 0.6 0.8 1 1.2 1.4 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree Freds Industry Average

Although the next two ratios -inventory turnover and working capital turnover- are classified as liquidity ratios, they tell more about a firms operating efficiency than its actual liquidity. The first of these to analyze is the Inventory Turnover. This ratio measures how frequently the inventory in a companys warehouse is used and replenished. The higher the number is the better because it indicates higher sales. This number is found by dividing the cost of goods sold 58 by the inventory and it tells us how many times per year the inventory is replenished. Dollar General, being the industry leader, has consistently had one of the highest inventory turnovers in the industry. Inventory Turnover for the past 5 years 2002 2003 2004 2005 2006 Dollar General 3.37 3.9 4.19 3.92 4.15 Family Dollar 0.64 0.6 0.59 0.06 0.08 Dollar Tree 0.26 3.4 3.27 3.85 4.32 Freds 4.04 4.13 3.9 3.76 3.76 Industry Avg. 2.077 3.01 2.98 2.89 3.078 The cross sectional analysis below shows the industry and its trends over the past five years. Family Dollar is well below the industry standard, showing that they are not selling efficiently enough to keep up with the industry. Dollar Tree experienced a tremendous amount of growth from 2002-2003 and has since been able to remain above the industry average; however if Family Dollar wasnt so low, bringing the average down, Dollar Tree would probably be just below the industry average up until the past year or so. Freds has one of the higher turnovers of the industry showing very efficient sales, with a slight decline just recently. Dollar Generals ratio was rising until 2004 with a decline in 2005 and now is almost back on track. Dollar General has followed the industry trend more than any of other firms and has remained above the industry every year. Operating efficiency has been consistent with inventory turnover averaging four times a year. This shows that their inventory is fairly liquid with three month intervals out of the year. 59 Inventory Turnover
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree

Freds Industry average

The other liquidity ratio that measures operating efficiency is the Working Capital Turnover. This number is found by dividing a companys sales by its working capital, working capital being the companys current assets less its current liabilities. Working capital measures how many sales dollars every one dollar of working capital can generate. The higher this number is the better, because it indicates higher sales. Dollar General has set the industry standard for working capital turnover and has had the highest turnover every year for the past five years with the exception of 2004. Since 2004, Dollar General has had a steadily rising turnover. Working Capital Turnover Below is the cross sectional analysis of Dollar Generals working capital turnover as well as its direct competitors and the industry as a whole. As you can 2002 2003 2004 2005 2006 Dollar General 12.6 9.25 7.56 8.46 10.35 Family Dollar 0.24 0.25 0.3 0.27 0.08 Dollar Tree 0.32 6.12 4.63 5.24 6.89 Freds 6.58 7.97 7.87 7.08 7.43 60 see Dollar General leads the industry and has had the highest turnover every year for the past five years, with the exception of 2004, where they were just barley behind Freds. Since 2003 Dollar General has been setting the trends for the industry. Family Dollar has a very low turnover relative to the other companies, while Freds and Dollar Tree are just a little behind Dollar General. Working Capital Turnover
0 2 4 6 8 10 12 14 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree Freds Industry average

The nature of the discount retail industry does not entail the need for accounts receivables. The industry is dependent on the volume of purchases because basic commodities are sold at low prices. As a result, the average customer purchase was $9.36 in 2006. (Dollar General 10-K) Therefore the accounts receivable turnover ratio will not be calculated for Dollar General. If the receivables turnover ratio were to be calculated, it would be performed by taking total sales and dividing it by accounts receivable. This would be a valuable tool for determining the corporations cash to cash cycle. This is the

measure of how long it would take to free up cash from accounts receivables and inventory. The faster the cycle is the more amounts of cash is available for operations and reducing debt. The only part of this cycle that Dollar General can monitor is the day supply of inventory. In essence, the cash to cash cycle for the 61 industry is just the day supply of inventory. This is first half of the cash to cash cycle. This is calculated by taking the number of days in the year and dividing it by the inventory turnover ratio. The smaller the ratio is the better it is for the firm. It states how many days inventory stays in storage instead of being sold on the floor. Below is a chart showing the day supply of inventory for Dollar General and the industry. They have been leading the industry with Freds and have remained below the industry average. This is favorable because it shows that inventory is generating revenue instead of sitting in storage.
Day Supply of Inventory
0 1000 2000 3000 4000 5000 6000 7000 2002 2003 2004 2005 2006

Dollar General Family Dollar Dollar Tree Freds Industry Average

Liquidity overview Over the past five years Dollar General has followed the industry liquidity trends quite consistently and has set the trends in inventory and working capital turnover. Dollar General is quite liquid in comparison to the industry which means they are able to quickly convert their cash to assets if necessary to meet current and upcoming obligations. Dollar General has shown great ability to generate sales over the past five years and is the leader in its industry. 62 Profitability Ratios The basis of profitability ratios is to determine the rate at which a company can turn a profit off of operations. Four main factors determining profits are operating efficiency, asset productivity, rate of return on assets, and rate of return on equity. The overall goal of any company is to make sales at the lowest cost feasible to achieve profits. This operating efficiency is measured by the gross profit, operating profit, and net profit margin. Asset productivity is the efficiency rates a company can turnover investments of assets into revenue. This is calculated by the ratio of return on assets. Lastly, the rate of return on equity measures the effectiveness a company can produce earnings growth from investments. Gross Profit Margin
0 0.05

0.1 0.15 0.2 0.25 0.3 0.35 0.4 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree Freds Industry average

The gross profit margin ratio measures the gross profits of the company to the amount of sales. We can determine how well a company has minimized cost of good sold. According to the graph, Dollar General has maintained about a 25 to 30% ranges on it gross profit margin for the past five years. Freds Inc has 63 remained about the same as Dollar General, but Dollar Tree has minimized more cost of good sold and created more profit. Dollar Tree has done average on its profit margin, but as Dollar Trees ratios prove, Dollar General can improve on its efficiency whether it is improving inventory costs or finding cheaper suppliers. Operating Profit Margin
-0.06 -0.04 -0.02 0 0.02 0.04 0.06 0.08 0.1 0.12 2002 2003 2004 2005 2006 Dollar General Family Dollar Dollar Tree Freds Industry average

Operating profit ratio measures the same thing the gross profit ratio measures, but it includes selling and administrating expenses. Once again, Dollar General has maintained an average percentage of the past five years of around 7 %. Compared to Freds Inc, Dollar General has done well to keep costs at a minimum. As before, Dollar Tree has maintained greater efficiency of the past five years on average, but we should expect this because their gross profit margin was higher. Once again we did not include Family Dollar in our valuation of Dollar General though we did consider that Family Dollar did have a higher operating profit ratio in 2006. We have concluded from the above data that Dollar General is only doing average to the rest of the market. The trend of the overall industry seems to be converging on Dollar Generals position, but we believe that Dollar General can improve its position in the industry by getting rid

of excess cost. 64 Net Profit Margin -0.08 -0.06 -0.04 -0.02 0 0.02 0.04 0.06 0.08 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average The net profit margin considers the overall effect of expenses compared to sales and other income. We see that Dollar General has flat lined over the past five years. They have no trends of growing or shrinking and have maintained about a 4% net profit. The slightly higher margin for Dollar General is because of an interest income. Dollar Generals competitors Family Dollar and Dollar Tree have done a slightly better job over the past five years except for 2006 where Family Dollar has incurred more costs. Freds Inc. has done the worst in the industry with a ratio of only 2% in the past two years. Dollar General has a good job of maintaining a near average ratio margin, but competitors are doing better which means Dollar General is not as efficient as they could be. 65 Asset Turnover 0 0.5 1 1.5 2 2.5 3 3.5 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry

average The asset turnover ratios were used earlier as an expense diagnostic. We have now used average assets instead of total assets. The asset turnover ratios show that for every dollar of assets the company has a certain number of sales will be made. In the past five years, Dollar General has improved their revenue profitability. In 2002, they were getting two dollars worth of sales for every asset. They have steadily increased this number over the past five years and in 2006 they are up to about 3.2-3.3 dollars per asset. Compared to the competitors only Freds Inc has done a better job of asset turnover then Dollar General. Freds inc. high asset turnover can be explained by size. They have far less inventory and are a much smaller company then the other three companies. Family Dollar has maintained a 2.5 asset turnover which is only slightly up from past years. Dollar Tree has been lagging behind at 2.2 asset turnovers which have been slightly better then past years. We can conclude from this information that Dollar General is doing a good job of using assets to support sales volume. 66 Return on Assets -0.02 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average The return on asset is the overall measure of profitability. It uses the net income and the average total assets which include parts of other ratios mainly net profit margin and asset turnover ratio. By dividing net income by assets we can determine the return on the assets. We hope to see a greater percentage from year to year. As the graph displays, Dollar General over the past five years has increased its ROA except for the last year. It is now at a 12 % ROA down from 13% the year before, but the company has improved its ROA from 2002 where it was at a 9% ROA. Dollar General has done relatively well against its competitors. Dollar Tree has maintained a 10 % ROA in the past three years while Family Dollar and Freds Inc are down to 5% ROA. We can conclude from this information that Dollar General is doing overall better on its profitability from

asset productivity and operating efficiency compared to the other companies in the industry. However, the recent decline, which is slightly unfavorable, in ROA may be signaling a downward trend which could bring it further down to the industry average. 67 Return on Equity -0.05 0 0.05 0.1 0.15 0.2 0.25 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average The Return on equity is the net income of the company divided by the past years owners equity. The ROE measures the amount of the owners interest in total assets (class notes). We expect to this ratio much larger then the ROA because equity is only a part of assets and would only equal ROA if the company had no debt. As you can see from the chart, Dollar General finances its operation with great debt then the other companies. Overall, Dollar general has maintained about the same mount of return for the past 5 years. The others companies have lower ROE this could be due to the fact that they finance there companies operations with less debt. The more profit a company gets each year we should see an increase in ROE. The past five years there has not been a significant increase in ROE. We do not to expect to see much change in ROE in the next few years because of the competitive nature of the industry. Dollar General may have a slight advantage because of their leverage as long as they can maintain there debt covenants. 68 Profitability overview In conclusion Dollar General has by and large has followed the industry trends in profitability. Dollar General has a lower gross profit margin and a slightly lower net profit margin recently. While the gross profit has remained lower than the industry, it has still followed it. However net profits has remained almost constant over the past five years, since sales have been rising. There is obvious room for improvement here. Seeing that the operating profit and net profit have remained constant over the past five years while gross profit has risen it shows us that general selling and administrative costs might need to be cut in order to start increasing profit. They have set the industry trends for asset

turnover and their return on equity and have lead the industry in return on assets. Overall Dollar General is the industry leader and has maintained its ability to generate profit, with some slight room for improvement. Capital Structure Ratios The capital Structure Ratios are designed to identify how much of the firms assets are financed through debt and owners equity. The next three ratios, Debt to Equity ratio, Time Interest Earned, and Debt Service margin, will present how much each firm in the industry invests in debt. They will also consider how well the company can meet its debt obligation requirements. We will use these ratios to evaluate Dollar General to the rest of the industry and draw conclusions about the ability of the company to manage its capital structure. 69 Debt to equity 0 0.5 1 1.5 2 2.5 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average The debt to equity ratio takes the total liabilities and divides them by the total owners equity. This ratio gives us an idea of the weight of liabilities compared to owners equity. Knowing these ratios gives us an idea of what the companys credit risk can be and how it compares to other companies. Dollar General in 2002 was financing its company with over 2 dollars debt to 1 dollar owners equity. In the next few years, they took several steps to reduce liabilities and maintain proper debt leverage. They have managed to lower their debt to equity to just below 1. The competitors have had significantly lower debt to equity ratios. Most companies have financed most of their assets with owners equity. Family Dollar is the only company that has increased to 1 dollar of liabilities to 1 dollar of owners equity. We believe it is important for Dollar General to maintain low levels of debt obligation. The nature of the discount retail industry gives very little leeway. If a company falls into debt, it is much harder to gain the resources to pay off debt obligations because of the highly competitive nature of the industry. 70 Times Interest Earned -50 0

50 100 150 200 250 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average The times interest earned ratio tells us is how long it takes a company to operate to cover the cost of interest expense. This is important because a company would want to have high earnings with low interest expense. The ratio is calculated by taking the operating income before interest and taxes and dividing it by interest expense. As interest expenses increases for a company it reduces the profits towards adverse conditions. Dollar Generals ratios have been on a steady increase for the past five years merging to the market trend in 2006. This shows that Dollar General is about par with the industry regarding interest costs. If this ratio were to deviate from the industry norm, this would be a red flag to alert managers that something could be awry. The stable increase in this ratio for Dollar General shows favorable growth in operating income to interest expense. This is crucial because income from operations should be adequate enough to cover expenses otherwise it could lead a decrease in profits. It is important to note that Freds Inc. ratios are considerably higher than the industry because of their high operating income in relation to interest expense. 71 Though they are a competitor of Dollar General, it should not be a benchmark because their ratios are higher than the industry average year to year. Debt Service Margin -0.5 0 0.5 1 1.5 2 2.5 2002 2003 2004 2005 2006 Dollar General Dollar Tree Family Dollar Freds Industry average

The debt service margin reveals the capability of a company to pay annual installments of long term liabilities. This is calculated by dividing cash from operations by installment payments of long term debt. It would be favorable for a company to have a ratio greater than 1 because it shows that enough revenue is being generated to cover long term debt. The greater the ratio the better off a company is financially. In 2002, Dollar Generals ratio was at low of .78 but increased to above 2 in 2006. This is a valuable tool to an analyst because it tells if a company is able to pay off its long term debt. It would be concerning if the ratio was consistently under 1 year after year showing more debt than incoming cash. In comparison to Dollar Generals competitor Dollar Tree, their ratios are above 1.5 in 2006. This is a favorable ratio for the two companies after both dropping .5 respectively within the past 3 years. There was not enough data available to calculate the ratio for the rest of the competitors. 72 Though this does not show a complete trend in the industry, we felt that it was sufficient enough in comparison to Dollar Tree. Capital Structure overview Capital structure ratios show how a firm is financed. While Dollar General has a lot of debt in comparison to the industry, they have greatly reduced it over the past five years and are continuing to do so. Also they have had a consistent increase in their ability to pay they interest on this debt, as well as steady increase in their ability to pay their long term debt (with the exception of 2005). Overall this shows Dollar General has been improving their capital structure over the past five years and will most likely continue to do so in the future.

IGR/SGR Ratios

When forecasting a companys future outlook, it is important to know what the internal growth rate (IGR) and the sustainable growth rate (SGR) is. The SGR is the maximum amount of growth a company can maintain without increasing its debt. On the other hand, the IGR is the peak at which a company may grow without external financial assistance. These ratios will help determine how much of the projected growth will be funded by operations instead of borrowing. In order to be competitive in the discount retail industry, a company must grow but not a large expense of debt. These growth rates are a key to determine how successful future developments will be. 73 IGR
0 2 4 6 8 10 12 14 2002 2003 2004 2005 2006 2007 Freds dollar tree family dollar Dollar general

industry

As shown above, the IGR for Dollar General is leveling off after peaking in 2004. The internal growth rate for the industry appears to be decreasing across the board. Although rates are decreasing, Dollar Generals rates are well above its competitors. This indicates they are able to grow with less financial debt, which increases net income in the long run. This is favorable because it allows room for growth in the industry without the expense of debt. Internal growth rate is calculated by multiplying the return on assets by one minus dividends divided by net income. Return on assets is a large factor in determining how much a firm may grow. As more revenue is generated from assets, more will be allocated towards net income and will be available for future expansion. 74 SGR
0 5 10 15 20 25 2002 2003 2004 2005 2006 2007 freds dollar tree family dollar dollar general industry

Sustainable growth rate is affected by the internal growth rate and the debt to equity ratio. It is calculated by multiplying the IGR by one minus the debt to equity ratio. It is beneficial to have a higher IGR to sustain the companys growth. As shown in the above chart, Dollar General is able to sustain their growth well above their competitors. This is explained by keeping the debt to equity ratio as low as possible. It is beneficial for a company to maintain a fair amount of debt and equity for operations. If Dollar General were to increase the amount of debt used to finance their operations it would cost more reducing profits. Analyzing the IGR and SGR for Dollar General reveals that they are able to experience growth in the future with minimal debt. Maintaining a good ratio of return on assets and a low debt to equity makes this possible. In order for Dollar General to remain profitable in the discount retail industry, they must 75 grow by increasing sales and improving their market presence. Generally speaking, these growth rates are an encouraging sign for the future of this company. Forecasting financial statements Forecasting a firms financial statements will help us to understand where the company stands and where the company will be in the future. To forecast Dollar Generals financials, we took the past 5 years of the companys financials and forecasted those 10 years out to the future. We forecasted the income statement using assumptions from the past 5 years of sales and looking at the

industry trend. To forecast the balance sheet, we took into factor Dollar Generals inventory turnover ratio, current ratio, and asset turnover ratio. We forecasted the statement of cash flows by taking into account the cash flow from operations divided by net income (CFFO/NI), cash flow from operations divided by sales (CFFO/SALES), and cash flow from operations divided by operating income (CFFO/OI) ratios. Income Statement Forecasting our financial statements was required to perform a prospective analysis of Dollar General. These projected statements form the foundation to determine the corporations future potential. Long term forecasts of 10 years were implemented which implied that assumptions were made on our behalf. The first financial statement to forecast is the income statement. This is the easier statement to forecast out of the three statements and require fewer assumptions on our behalf. Since this has the fewest assumptions of the forecasted statements, this is considered to be the most accurate. Dollar General has already released its first 10-Q of the year on May 4, 2007. This means that there is already accurate data for the first quarter to base our forecast on for the remaining year. To start off, we assumed a growth of sales 76 to be 10%. This growth rate was derived from the average of the past five years of sales reported on the income statement. We felt that this was an efficient growth rate because between the years of 2003 and 2006 the average growth rate was 11%. We assumed a more reserved growth rate of 10% to forecast our variable sales from new store openings and upcoming product lines. Dollar General is below the industry average of 13.06%, but is trying to increase sales by adding a wider variety of merchandise. The estimate of our cost of goods sold is approximately 73% of net sales each year. This was determined from our common sized income statement shown below. Common size Income Statement The common size income statement is a reflection of the income statement but every line item as a percentage of sales. Sales starts out as 100% and every item on the income statement are divided by sales. From this we determined our cost of goods sold to be 72.95% of our base years of 2002-2006. Using the same methodology with the common size income statement, we forecasted interest expense, operating income, and selling, general and administrative (SG&A) expenses. Net income was forecasted using a growth rate of 9%. The percentage was a result from the average growth for the past five
Dollar General Actual Financial Statement Forecast Financial Statement 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net sales 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Cost of goods sold 72% 71% 70% 71% 73% 73% 73% 73% 73% 73% 73% 73% 73% 73% 73% Gross profit 28% 29% 30% 29% 27% 27% 27% 27% 27% 27% 27% 27% 27% 27% 27% SG&A Expenses 21% 22% 22% 22% 21% 21% 23% 23% 23% 23% 23% 23% 23% 23% 23% Operating profit 7% 7% 7% 7% 6% 6% 4% 4% 4% 4% 4% 4% 4% 4% 4% Interest expense 1% 0% 0% 0% 0% 0% 1% 1% 1% 1% 1% 1% 1% 1% 1% Income before income taxes 7% 7% 7% 6% 6% 6% 2% 2% 2% 2% 2% 2% 2% 2% 2% Total current income taxes 1% 2% 2% 2% 2% Income taxes 2% 3% 2% 2% 2%

Net income 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4%

77 years. With a few reasonable assumptions made on our behalf of past information, the groundwork of our forecast is completed with the income statement.
Dollar General Actual Income Statement Forecasted Income Statement *In millions 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net sales 6100 6871 7660 8582 9526 10478 11526 12679 13947 15342 16876 18564 20420 22462 24708 Cost of goods sold 4376 4853 5397 6117 6912 7644 8408 9249 10174 11192 12311 13542 14896 16386 18025 Gross profit 1724 2018 2263 2464 2613 2834 3117 3429 3773 4150 4565 5021 5524 6076 6684 SG&A 1296 1496 1706 1902 2000 2200 2674 2941 3236 3559 3915 4307 4737 5211 5732 Operating profit 457 511 556 561 613 633 443 488 537 591 650 715 786 865 951 Interest expense 42 31 28 26 23 21 168 185 204 224 247 272 299 329 361 Income before income taxes 414 479 534 544 589 612 275 302 333 366 403 443 487 536 590 Total current income taxes 66 158 164 186 200 Income taxes 149 178 190 194 197 Net income 264 301 344 350 391 427 465 507 553 603 657 716 781 851 928

Balance Sheet The next financial statement in line to forecast is the balance sheet. This will be a little less accurate because this forecast will be based off our forecasted data from the income statement instead of past balance sheet numbers. To forecast the balance sheet out ten years into the future, we enlisted the aid from a few liquidity ratios covered earlier. The first line item to forecast is inventories. To maintain consistency, we used the inventory turnover liquidity ratio. The basis of this ratio is to take costs of goods sold and divide it by inventory. For Dollar General the ratio is four, stating that inventory is replenished four times a year. Since we already have the costs of goods sold forecasted from our income statement, we manipulated the formula to determine that inventory is approximately a quarter of costs of goods sold projected annually. The next item in line is total assets. For this, we used the asset turnover ratio which is sales divided by total assets. As previously discussed, Dollar Generals asset turnover ratio in 2006 is 3.1. From this we rearranged the equation and forecasted total assets as a third of sales each year. The next 78 major item in our balance sheet to forecast is total current liabilities. For this account, we used the current ratio to project the estimated data. The current ratio is a result of taking current assets and dividing it by current liabilities. We took the industry average of 2.1 for this ratio and used it as a tool to predict our current liabilities. At this point of the forecast, it is important to make sure the financial statements flow together. We need to make sure our statements reflect the flow of cash from net income into our retained earnings on the balance sheet. Our forecasted retained earnings is a result of our previous years retained earnings plus next years net income and subtracting next years dividends. This is repeated for the remainder of the forecast of retained earnings. The flow of cash is shown in the table below. Statement of Retained Earnings
Forecasted Financial Statement *In thousands 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Beg RE 1,434,537 1,808,385 2,218,670 2,669,308 3,164,932 3,710,230 4,310,932 4,970,105 5,693,336 6,486,651 Net Income 426,020 464,363 506,155 551,708 601,362 655,485 714,479 778,782 848,872 925,271 Dividends 52,172 54,078 55,517 56,084 56,064 54,783 55,306 55,551 55,557 55,452

End RE 1,434,537 1,808,385 2,218,670 2,669,308 3,164,932 3,710,230 4,310,932 4,970,105 5,693,336 6,486,651 7,356,470

79
Dollar General Actual Balalnce Sheet Forecasted Balance Sheet *In Millions 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash & cash equivalents 121 398 232 200 189 Short-term investments - - 42 8 29 Merchandise inventories 1123 1157 1376 1474 1432 1860 2069 2301 2559 2847 3167 3522 3918 4358 4847 Deferred income taxes 33 30 24 11 24 Prepaid expenses & other current assets 45 66 53 67 57 Total current assets 1323 1652 1730 1762 1742 1948 2167 2410 2681 2982 3317 3689 4104 4565 5077 Land & land improvements 145 145 145 147 147 Buildings 333 333 333 381 437 Leasehold improvements 157 170 191 209 212 Furniture, fixtures & equipment 940 1039 1196 1437 1617 Construction in progress 1 19 74 46 16 Gross property & equipment 1577 1709 1940 2221 2430 Less accumulated depreciation & amort. 584 720 859 1029 1193 Net property & equipment 993 989 1080 1192 1236 1283 1427 1587 1765 1964 2184 2430 2702 3006 3344 Other assets, net 15 11 29 37 60 Total Long-term assets 1010 1000 1111 1230 1298 1341 1492 1660 1846 2053 2284 2541 2826 3143 3496 Total assets 2333 2652 2841 2992 3040 3290 3659 4070 4527 5036 5601 6230 6930 7708 8574 LIABILITIES AND OWNER'S EQUITY Current portion of long-term obligations 16 16 12 8 8 Accounts payable 341 383 409 508 555 Accrued compensation & benefits 63 78 72 53 41 Accrued insurance 73 97 118 154 76 Accrued taxes (other than taxes on income) 29 35 39 58 50 Accrued expenses & other current liabilities 239 297 333 372 253 Income taxes payable 67 45 69 43 15 Total current liabilities 664 743 825 933 832 927 1031 1147 1276 1420 1579 1757 1954 2173 2417 Notes 199 199 199 199 199 Tax increment financing - - - 14 14 Capital lease obligations 52 38 28 22 18 Financing obligations 94 44 43 42 37 Long-term obligations, incl current portion 346 282 271 278 270 Less: Current portion 16 16 12 8 8 Long-term obligations 330 265 258 269 261 Deferred income taxes 50 66 72 67 41 Other liabilities - - - - 158 Total liabilities 1751 1653 1708 1832 1838 3288 3283 3284 3290 3303 3324 3352 3393 3448 3520 SHAREHOLDERS EQUITY Common stock 166 168 164 157 156 Additional paid-in capital 313 376 421 462 486 Retained earnings 812 1037 1102 1106 1434 375 785 1236 1731 2277 2877 3537 4260 5053 5923 Accumulated other comprehensive income -1 -1 -0.97 -0.79 -0.99 Shareholders' equity before undernoted 1290 1581 1687 - Less com stk purch by employ dfd comp trust 2 2 - - Less unearned comp rel to outstg restrict stk - 1 - - Other shareholders equity - - -2 -4 0.42 Alternative equity 1291 1583 1684 -4.79 -0.57 Total shareholders' equity 1288 1576 1684 1720 1745 2075 375 786 1236 1732 2277 2878 3537 4260 5054 Total Liabilities and equity 3039 3229 3392 3552 3583 3290 3659 4070 4527 5036 5601 6230 6930 7708 8574

80 Statement of Cash Flows To begin our forecast of Dollar General, we took our forecasted net income and stated it in the cash flow. We took into account depreciation of plant, property, and equipment and saw how vital the depreciation was to Dollar Generals cash flow. Our forecasted growth rate for depreciation is 7%; our net income growth rate of 9% makes it seem reasonable to have depreciation growth in the area of our net income growth. We forecasted the operating activities which grew in total over the ten years by 150% with a growth rate of 11%. We forecasted the dividends by taking the average cash dividends paid

from the past five years. We choose this method because we believe it is highly unpredictable when and how much a firm is willing to pay dividends. We have concluded that the statement of cash flows is by far the hardest set of financials to forecast. * See Appendix 81

Cost of capital estimation

A proper valuation of a firms projected growth and success requires an estimate of its cost of capital. This cost amounts to all the acquisitions that bring or add value to a firm or corporation. As a leader in the discount retail industry, Dollar General makes a number of strategic moves such as opening new stores and adding new inventory to maintain its position. This of course costs the corporation capital and should be monitored carefully to supplement the expected growth. Calculating the cost of capital requires the cost of debt and equity to be determined first. Dollar Generals cost of debt was not explicitly stated in our 2006 10-K so an estimate was needed. This was achieved by using the most recent balance sheet from the 10-K. The weighted average cost of debt before taxes was used to establish our cost of debt. We took the current and long term liabilities and figured the value of its weight in terms of total liabilities and multiplied this by the market interest rate. For the market interest rate, we used the 3 month non-financial commercial paper rate from the St. Louis Federal Reserve website. The sum of each line item of liabilities resulted in a cost of debt of 5.19%. Another estimate was needed for the cost of equity for Dollar General. This was achieved by running a sequence of regression analysis to measure the variables involved in calculating the cost of equity. A regression analysis measures the relation of a dependent variable to a specified independent variable. In our case, the dependent variable is the market risk premium and the independent variable is the returns on the shares. In this estimation process, we needed the T-Bill rate from the Federal Reserve. The regression analysis was implemented for five different time periods of 3 months, 6 months, 2 ,5, and 10 years. This was used to establish which variables would provide the most accurate data to determine the cost of equity. After running the series of regressions, the results were close across all the time tables. From 2 months to 10 years, the output was similar. The could be explained by the stable nature of 82 the discount retail industry where there is constant market risk, from changes in stock prices and interest rates that will not likely alter between time periods. From the regression, we took the beta with the highest explanatory power. Our beta appeared fairly stable and consistent across all the regression periods and years. The beta would decrease from 72 months all the way to 24 months. Regression output 3 month 6 month
Beta

R square Beta R square 72 1.19 0.19 72 1.19 0.19 60 1.02 0.14 60 1.02 0.14 48 1.5 0.14 48 1.5 0.14 36 0.53 0.02 36 0.53 0.02 24 0.28 0 24 0.29 0

2 years 5 years

Beta R square Beta R square 72 1.19 0.19 72 1.19 0.19 60 1.02 0.14 60 1.01 0.14 48 1.51 0.14 48 1.51 0.14 36 0.54 0.02 36 0.54 0.02 24 0.31 0 24 0.31 0

10 years

Beta R square 72 1.18 0.18 60 1.01 0.14 48 1.51 0.14 36 0.54 0.02 24 0.31 0

The explanatory power yield is a key factor in determining the cost of equity because it interprets the degree of the output as a result of the input. With this said, the highest amount we received from the regression was 19%. This is not a strong and convincing number to base our results on. This means that 81% of the ensuing estimated figures are not a result of the inputs. A slight 83 decrease in the explanatory power from the 10 year to the 5 year regression indicates that a shorter term would provide to some extent, higher assurance in the results. Using this as a guide, and our stable results of beta we are now almost able to calculate the cost of equity using the capital asset pricing model. The next item in line to find is the risk free rate. For this rate we used a 1-year treasury constant maturity rate of 4.98% from the St. Louis Federal Reserve website. Referring to the textbook, Business valuation and analysis, when analysts use the rate of treasury bonds as the risk free rate, the average common stock return (based on returns of the S&P 500 index) have exceeded that rate by 7.0 percent. (Palepu 8-3) Adopting this technique and using the capital asset pricing model, we concluded that our cost of equity is 12.09%. Our cost of debt was calculated from determining the weighted average cost of debt from our most recent 10-K. We observed the stated long term debt and took the weighted average of it. Once again, we used an interest rate from the St. Louis Federal Reserve website. The 3 month non-financial commercial

paper rate was implemented as our rate of interest. From this, we multiplied each weighted average debt by this rate and resulted with the value weighted rate. The resulting sum of these calculations turned out to be Dollar Generals estimated cost of debt before tax. WACC estimation Now that we have found the estimated cost of debt and equity, we can calculate the weighted average cost of capital. The value of equity was determined by taking the total number of outstanding shares and multiplying it by the share price. These figures were attained from the date of valuation of June 1, 2007. Dollar Generals market value of debt was determined to be the book value of its total liabilities. Adding these two amounts together gives the approximate value of the firm. From the stated values, our estimated WACC is 10.99% before tax. Dollar General reports a tax rate of 35% in their most recent 84 10-K, therefore we will use this as the effective tax rate to determine WACC after tax has been implemented. The after tax WACC is 10.7%. WACC (revised) Capitalizing Dollar Generals operating leases increases their liabilities by 1.2 billion. This has no effect on the cost of equity. This is a result of taking lease expenses off the income statement and adding it to liabilities and assets on the balance sheet. The capital asset lease account increases by the same amount as debt when this is done. As a result, the debt to equity ratio increases from .74 to 1.45. This in turns causes their cost of debt to increase by 8%. This causes the cost of debt to be approximately twice as less as the cost of equity. From the revision, we recalculated Dollar Generals WACC to be 11%. Valuation Analysis In the previous sections, we have analyzed Dollar Generals industry, accounting, and financials. With all the data that we have gathered, we can price the company relative to the industry and put a value on the company. There are several ways in which we can price Dollar General. In the next few sections, we will run several different methods of valuing price. Each method we use will give us an idea on determining if the company is overvalued, undervalued, or fairly valued. We will be taking into account a mixture of financial and accounting methods. To begin, we will use method of comparables. The ratios we will be using consider the average of the industry and price Dollar General relative to the other firms. The method of comparables is relatively inaccurate due to the fact that we are taking the average of the industry and the amount of variation is high. After we have priced the company comparatively, we will use several theoretical valuation models. The theoretical models are more reliable. The 85 theoretical model take forecasted information and determines the present value of the company. After we have collected all the data from the method of comparables and

theoretical model valuation, we can then determine weather or company is valued correctly. Our overall valuation will consider all the information from previous sections as well as the price that we determine to be most accurate. Method of comparables The Method of comparables uses several ratios to value the firm. We will be taking the industry average for each ratio excluding Dollar General. We will then determine a price relative to the industry average using algebra. We will be pricing Dollar General using the P/E ratio (trailing and forecasted), the P/B ratio, the P.E.G. ratio, the P/EBITDA ratio, P/ FCF ratio, and Enterprise value/ EBITDA. After we have calculated each ratio, we will determine whether Dollar General is overvalued, undervalued, or fairly valued compared to the industry average. Price to Earnings Ratio (Trailing) Millions PPS EPS P/E Industry Average $21.74 Family Dollar $35.11 $1.54 $22.80 Dollar General Estimated Price Dollar Tree $42.85 $1.93 $22.20 P $9.57 Fred's $13.55 $0.67 $20.22 Dollar General $21.76 $0.44 Valuation= Overvalued The trailing P/E Ratio prices the companies using past data and is very inaccurate since it is valuating the company based on past performance. According to the ratio, Dollar General is considerably overvalued. Dollar General 86 as of June 1st is selling at a price of $21.76. In our calculation, we determined that the price based on the past performance should be $9.57. We will not be considering this ratio as much as other on the pure fact that it does not accurately portray the future of the firm. Price to Earnings Ratio (Forecast) Millions PPS EPS P/E Industry Average $17.33 Family Dollar $35.11 $ 1.85 $ 18.98 Dollar General Estimated Price Dollar Tree $42.85 $ 2.41 $ 17.78 P= $7.80 Fred's $13.55 $ 0.89 $ 15.22 Dollar General $21.76 $0.45 Valuation= Overvalued The forecasted price to earnings ratio uses forecasted earnings to project what the price should be in the future. The forecasting P/E ratio does a better job of predicting the future price of a company then the trailing P/E. In the table above, we have calculated the forecasted price using the forecasting P/E. We calculated that the price of shares given the forecasted P/E should be $7.80. Once again, Dollar General is overvalued company if we use the forecasted P/E ratio as an indicator of price. The numbers still have the potential of being skewed because the earnings per share of each company have a large amount of variation. The industry average is still being used and therefore is very inaccurate. 87

Price to Book Ratio Millions PPS BPS P/B Industry Average $9.75 Family Dollar $35.11 $3.95 $8.89 Dollar General Estimated Price Dollar Tree $42.85 $3.87 $11.07 P= $54.00 Fred's $13.55 $1.46 $9.28 Dollar General $21.76 $5.54 Valuation= Undervalued The price to book value ratio takes the current price and divides it by the book value per share. Once we computed the P/B of each company, we took the average. We then were able to calculate the price of Dollar General given their book price per share of $5.54. We calculated the price given the book value to be $54. We calculated with the P/B ratio that the company is undervalued. We did not consider this calculation in are judgment of valuation. It is a very inaccurate estimation because of the book value being recorded under historical price. P.E.G. Millions PPS EPS Earnings Growth per share PEG Industry Average $1.30 Family Dollar 35.11 $ 1.85 12% 1.61 Dollar General Estimated Price Dollar Tree 42.85 $ 2.41 14% 1.27 P= $2.92 Fred's 13.55 $ 0.89 15% 1.03 Dollar General 21.76 $0.45 5% Valuation= Overvalued The PEG ratio uses the P/E ratio and divides it by the estimated growth of earnings. We calculated the average of every other companys PEG to be 1.30. By using algebra, we were able to back into the price of Dollar General given a 88 5% growth rate of earnings. We calculated the value of Dollar General to be .03 cents. Dollar General is overvalued given this information. We believe the estimates to be very inaccurate due to the fact that we collected unreliable data from yahoo finance, but used our calculations for Dollar General. There is just too much variation in the earnings growth and earnings per share to get an accurate picture of Dollar Generals price relative to the industry. Price to EBITDA Millions PPS EBITDA P/EBITTDA Industry Average $0.11 Family Dollar $35.11 $542.16 $0.06 Dollar General Estimated Price Dollar Tree $42.85 $488.80 $0.09 P $28.24

Fred's $13.55 $75.53 $0.18 Dollar General $21.76 $255.28 Valuation= Undervalued The price to EBITDA is removes the interest and tax expenses from the valuation. We calculated the industry average to be .11 cents. By multiplying the industry average by the EBITDA of Dollar General we were able to arrive at a price of $28.24. The price indicates that Dollar General is an undervalued firm. Once again, the information is inaccurate due to lack of other relevant factors. Price to Free Cash Flows Millions PPS FCF P/FCF Industry Average $0.001 Family Dollar $35.11 157645 $0.0002 Dollar General Estimated Price Dollar Tree $42.85 222100 $0.0002 P $123.39 Fred's $13.55 5770 $0.0023 Dollar General $21.76 123,393 Valuation= Undervalued 89 We calculated the average P/FCF to be $.001. We were able then to calculate the price of Dollar General by multiplying the FCF of 123,393 by the industry average P/FCF of $.001 to give us a price of $123.39. The P/FCF ratio undervalues Dollar Generals current price. Enterprise Value to EBITDA Millions EV EBITDA EV/EBITDA Industry Average $8.58 Family Dollar 5120 542.16 $9.44 Dollar General Estimated Price Dollar Tree 4360 488.8 $8.92 P= $3.54 Fred's 558 75.53 $7.39 Dollar General 7926 255.28 Valuation= Overvalued The EV/EBITDA ratio can be used to calculate the price of Dollar general as well. We arrived at an industry average of $8.58. We were then able to calculate Dollar Generals price by multiplying the industry average by 255.28. We then subtracted the value of liabilities and cash and financial investments. We then divide the number by the number of shares outstanding to reach a price of $3.54. The price indicates that Dollar General is an over valued Firm. Conclusion After calculating the comparable ratios, we came to the conclusion that Dollar General is an over valued firm. We believe however that the calculation were very inaccurate estimate of Dollar Generals price because of the industry average and the relative inaccurate information. The ratios are only able to calculate a small portion of information needed to value a firm. The ratios are also void of theory and common sense. However, the ratios do indicate slightly how well the company is doing relative to competitors, and given this we believe that Dollar Generals competitors are doing a better job. 90

Intrinsic Value Models The intrinsic value models are theoretical models that asses the forecasted information of a company and bring them back to present value. These models are more effective then the comparable ratios we calculated in the previous section. There are two types of models that we will be using. The discounted dividend model and the free cash flows model use financial data to compute a forecasted price on a company. The residual income incorporates financial and accounting data and uses these numbers to calculate a value for the company. The theoretical models use the data we calculated in our regression analysis and WACC. Each model will use the Ke we calculated or the WACC we calculated. Every model will calculate a present value factor which will be used to bring all the forecasted years back to the present. We will also use the perpetuity calculation for the last year and bring it back to present value using the previous years present value factor. We then can calculate everything we need to develop an intrinsic price. The models we are using are very important in our analysis because they give us the most accurate price we can calculate for Dollar General. There are still a few inaccuracies in these models just from the pure fact that we are using forecasted data. The models also dont consider conceptual analysis, but the models do give us a relative price so that we may value a firm based on quantitative measures. We will use the prices we calculate in each model along with the overall analysis to value our company. Discounted Dividends Model The discounted dividend model will be the first method we will use in calculating Dollar Generals intrinsic value. The equity value provided from this model is equal to the present value of expected future dividends. This method suggests that the firm expects to pay dividends to its shareholders for an indefinite life at a certain growth rate. We started by taking the dividends we 91 forecasted from our statement of cash flows for the next ten years and divided our cost of equity minus our estimated growth rate of 11%. Our cost of equity was calculated by using regressions from 3 month, 6 month, 2-year, 5-year, and 10-year time periods. We then choose the highest R square and with that Beta computed our cost of equity. We calculated our present value factor by dividing one, by one plus our cost of equity to the time powered. Then we took our forecasted dividends paid and multiplied them by our present value factor which discounted them back to present value. We also computed a perpetuity starting in 2018 by dividing the total dividends paid by our cost of equity minus our growth rate. This value plus the total dividends paid represents the intrinsic value of equity. We found the intrinsic price per share by dividing that number by the total shares outstanding. The implied price per share from this model was $18.94. This price is below the current share price of $21.76 which we can conclude is implying this firm is overvalued.

The sensitivity analysis helps to better understand if the firm is overvalued or undervalued by using different variables. In our discounted dividend model, we used the change in our growth and a change in our cost of equity to help us value the firm. From our model we can clearly see that Dollar General is overvalued. 92 Sensitivity Analysis Growth Ke Undervalued < 20.02 Overvalued > 23.50 N/A Free Cash Flows This model is calculated by taking the forecasted cash flows from operations and discounting them back to the present value. To do this we need the free cash flows, WACC, and the growth rate of the perpetuity. Our WACC estimate of 10.99% was used as the discount rate to find the present value factor. The factor was then multiplied by each free cash flow which brought it to the present value. The perpetuity was forecasted for 2018 and was divided by WACC less the growth rate. This perpetuity was then multiplied by the present value factor in year ten to get the present value. We then took the present value sum of free cash flows, added the perpetuity, and subtracted our book value of liabilities to get the value of Dollar Generals equity. Because this value was at the end of February, we forecasted three-months ahead as a value on June 1, 2007. The market value of equity is then divided by the total number of shares outstanding to give Dollar Generals intrinsic share price. Dollar General has different outcomes when using this model. This method is somewhat consistent on keeping the firm overvalued. Our estimate of WACC shows that the firm is overvalued except for the growth rate of the 0 0.02 0.04 0.06 0.11 0.14 2.74 2.93 3.2 3.59 6.9 0.13 3.01 3.25 3.6 4.15 10.34 0.1209 3.3 3.61 4.07 4.83 18.94 0.11 3.72 4.13 4.79 5.96 N/A 0.1 4.18 4.75 5.68 7.56 N/A 93 perpetuity being at 11%. There are a few cases where the outcome has shown that Dollar General was fairly valued and perpetuity growth rates being at 2% and 4%. Sensitivity Analysis Growth WACC Overvalued > 20.02

Fairly Valued Undervalued < 23.50 N/A RESIDUAL INCOME Residual income is what you earn when you create a result just once, then get paid for it periodically (yahoo finance), therefore the purpose of residual income is to earn more with assets already invested. The main aim for this model was to see how much money Dollar General is looking to earn in the future. The discount rate used in the calculation of residual income is the cost of capital (ke). Unlike the other valuation methods that use the cost of capital, we started off by calculating our book value equity per share by adding the book value from the previous year plus the earnings per share minus the dividends per share. Then we proceeded to calculate our normal earnings by multiplying the book value from the previous year by the cost of equity. To get the residual 0 0.02 0.04 0.06 0.08 0.08 14.88 19.67 29.27 58.08 n/a 0.09 11.89 15.22 21.2 35.17 105.01 0.1099 7.76 9.52 12.29 17.28 28.95 0.12 6.27 7.59 9.57 12.88 19.48 0.13 5.06 6.07 7.53 9.83 13.97 94 income we subtracted the normal income from net income. To calculate the present value of annual residual income we multiplied the residual income by 1/(1+ke)^n, which is the present value factor. We then calculated the total present value of annual residual income by multiplying the residual income by the present value of the annual residual income. We then discounted the perpetuity back to the present value using our growth rate of 11%. The growth rate used to discount the perpetuity is a negative growth rate because we are trying to bring the negative residual income back to zero, so if we used a positive growth rate then the negative value would just keep getting larger and larger. The sensitivity analysis table helps to illustrate how quickly the value gets to zero by changing the growth rate. Using the data we calculated, we determined that by using the residual income model Dollar General is overvalued. Sensitivity Analysis Growth Ke Overvalued > 20.02 Fairly Valued Undervalued < 23.50 N/A 0 -0.05 -0.11 -0.15 -0.2 0.09 24.68 19.81 17.19 16.17 15.29

0.11 16.41 14.18 12.84 12.29 11.80 0.1209 12.97 11.64 10.81 10.46 10.14 0.15 6.05 6.19 6.28 6.32 6.36 0.17 2.60 3.28 3.78 4.00 4.22 95 Long Run Residual Income The long run residual income model uses the ROE, Ke, and growth to predict the intrinsic value. We used three different sensitivity analysis tables to take in account different variation to growth, ROE and Ke. We used the formula: P0 = BVE(1+( ROE-Ke / Ke-G )

Using this formula to determine the price we calculated the prices on the tables below. According to the table, it is evident that our firm is greatly overvalued except for the first table in which we are not sure if it was just a calculation error. Growth

Ke Growth ROE 0.15 0.17 0.19 0.21 0.23 0.11 7.21 6.85 6.49 6.29 6.16 0.13 4.26 4.56 4.86 5.03 5.14 0.1507 1.21 2.20 3.19 3.73 4.07 0.17 NA 0 1.62 2.52 3.08 0.19 NA NA 0 1.26 2.05 0.15 0.17 0.19 0.21 0.23 0.09 0.67 1.35 2.2 2.77 3.17 0.11 0.94 1.8 2.75 3.32 3.7 0.1209 1.21 2.20 3.19 3.73 4.07 0.15 5.17 5.41 5.51 5.54 5.55 0.17 NA NA 11.01 8.31 7.41 96 ROE Ke *Assuming Average Long Run Growth Rate Overvalued > 20.02 Fairly Valued Undervalued < 23.50 N/A

Abnormal earning growth model (AEG)

The Abnormal growth model uses the cost of equity. The D.R.I.P. is first calculated by multiplying the cost of equity by the dividends from the previous year. Then the cumulative income is found by subtracting the earning per share of the current year from the D.R.I.P. Then we proceeded to find the normal income or the benchmark by multiplying one plus the cost of equity (1+Ke) by the earning per share from the previous year. The AEG is the result of

subtracting the normal income from the cumulative income. To find the present value of AEG we multiply AEG by its present value factor-the present value factor= 1/(1+Ke)^t-1. We used the last years Annual AEG as the perpetuity, then we discounted it back by dividing it by Ke minus the growth. The AEG model used the same concept as the residual income model because the growth 0.09 0.11 0.1209 0.15 0.17 0.11 3.98 5.60 7.21 30.78 NA 0.13 2.35 3.31 4.26 18.19 NA 0.1507 0.67 0.94 1.21 5.16 NA 0.17 NA NA NA NA 5.60 0.19 NA NA NA NA 15.7 97 used has to be negative in order to bring the perpetuity closer to zero instead of the latter. Growth Ke Overvalued > 20.02 Fairly Valued Undervalued < 23.50 N/A -0.1 -0.09 -0.08 -0.07 -0.06 0.14 7.34 7.31 7.27 7.23 7.19 0.13 7.93 7.89 7.85 7.81 7.76 0.1209 8.54 8.5 8.46 8.41 8.36 0.11 9.41 9.37 9.32 9.27 9.21 0.1 10.37 10.33 10.27 10.22 10.16 98

Appendix
Current Ratio
2002 2003 2004 2005 2006 DG 1.37 1.99 2.22 2.1 1.89 FDO 1.99 1.94 1.72 1.51 1.44 DLTR 2.88 2.73 3.29 3.19 2.5 FRED 3.27 2.55 2.55 2.76 2.58 AVG 2.3775 2.3025 2.445 2.39 2.1025

Quick Asset Ratio

2002 2003 2004 2005 2006 DG 0.23 0.18 0.54 0.33 0.22 FDO 0.41 0.35 0.21 0.16 0.22 DLTR 1.13 0.64 1.08 1.15 0.8 FRED 3.2 2.46 2.51 2.6 2.42 AVG 1.2425 0.9075 1.085 1.06 0.915

Inventory Turnover
2002 2003 2004 2005 2006 DG 3.37 3.9 4.19 3.92 4.15 FDO 0.64 0.6 0.59 0.06 0.08 DLTR 0.26 3.4 3.27 3.85

4.32

FRED 4.04 4.13 3.9 3.76 3.76 AVG 2.0775 3.0075 2.9875 2.8975 3.0775

99 Working Capital Turnover

2002 2003 2004 2005 2006 DG 12.6 9.25 7.56 8.46 10.35 FDO 0.24 0.25 0.3 0.27 0.08 DLTR 0.32 6.12 4.63 5.24 6.89 FRED 6.58 7.97 7.87 7.08 7.43 AVG 4.935 5.8975 5.09 5.2625 6.1875

Gross Profit Margin

2002 2003 2004 2005 2006 DG 0.28 0.28 0.29 0.3 0.29 FDO 0.33 0.34 0.34 0.33 0.33 DLTR 0.29 0.36 0.36 0.35 0.34 FRED 0.27 0.28 0.28 0.28 0.28 AVG 0.2925 0.315 0.3175 0.315 0.31

Operating Profit Margin

2002 2003 2004 2005 2006 DG 0.07 0.07 0.07 0.07 0.07 FDO n/a n/a n/a n/a 0.074 DLTR -0.05 0.1 0.09 0.08 0.08 FRED 0.03 0.04 0.04 0.03 0.03 AVG 0.016667 0.07 0.066667 0.06 0.0635

100 Net Profit Margin

2002 2003 2004 2005 2006 DG 0.04 0.04 0.04 0.04 0.04 FDO 0.05 0.05 0.05 0.04 0.03 DLTR -0.07 0.06 0.06 0.05 0.05 FRED 0.02 0.03 0.03 0.02 0.02 AVG 0.01 0.045 0.045 0.0375 0.035

Asset Turnover
2002 2003 2004 2005 2006 DG 1.99 2.28 2.57 2.86 3.21 FDO 2.37 2.39 2.44 2.42 2.53 DLTR 0.12 1.89 1.74 1.89 2.12 FRED 3.21 3.19 3.15 3.1 3.19 AVG 1.9225 2.4375 2.475 2.5675 2.7625

ROA
2002 2003 2004 2005 2006 DG 0.09 0.1 0.13 0.13 0.12 FDO 0.07 0.07 0.07 0.05 0.05 DLTR -0.01 0.12 0.1 0.1 0.1 FRED 0.07 0.08 0.08 0.06 0.05 AVG 0.055 0.0925 0.095 0.085 0.08

101 ROE
2002 2003 2004 2005 2006 DG 0.2 0.21 0.19 0.2 0.2 FDO 0.11 0.11 0.11 0.09 0.1 DLTR -0.01 0.18 0.15 0.15

0.16

FRED 0.09 0.11 0.12 0.09 0.08 AVG 0.0975 0.1525 0.1425 0.1325 0.135

Debt to Equity Ratio

2002 2003 2004 2005 2006 DG 2.16 1.08 0.86 0.85 0.9 FDO 0.46 0.45 0.52 0.63 1.02 DLTR 0.54 0.46 0.54 0.53 0.6 FRED 0.3 0.38 0.42 0.48 0.47 AVG 0.865 0.5925 0.585 0.6225 0.7475

Times Interest Earned

2002 2003 2004 2005 2006 DG 8.16 10.72 16.23 19.34 21.42 FDO n/a n/a n/a n/a 23.76 DLTR -11.72 35.03 28.51 20.17 18.84 FRED n/a 210.23 127.19 49.1 40 AVG -1.78 85.32667 57.31 29.53667 26.005

102 IGR
2002 2003 2004 2005 2006 2007 Freds 0.07 0.08 0.08 7.4 4.95 dollar tree 0 0.12 0.1 0.1 0.1 family dollar 12 11.2 10.2 7 5.4 Dollar general 7.16 8.64 10.89 10.91 10.33 industry 6.41 4.98 5.3225 6.3525 5.195 0.1

SGR

2002 2003 2004 2005 2006 2007 freds 9 11 14.4 10.91 7.27 dollar tree 0 0 17.52 15.4 13.3 16 family dollar 17.5 16.2 15.5 11.4 10.9 dollar general 22.62 17.97 20.25 20.18 19.63 industry 12.28 11.2925 16.9175 14.4725 12.775 16

103 Regressions 3 month

SUMMARY OUTPUT Regression Statistics Multiple R 0.437668942 R Square 0.191554103 Adjusted R Square 0.180004876 Standard Error 0.090997736 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.137340843 0.137340843 16.58588069 0.000120756 Residual 70 0.579641155 0.008280588 Total 71 0.716981999 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00827982 0.010727215 0.771851759 0.442800225 -0.013114936 0.029674575 -0.013114936 0.029674575 X Variable 1 1.197711529 0.294091831 4.072576664 0.000120756 0.611163874 1.784259183 0.611163874 1.784259183 SUMMARY OUTPUT Regression Statistics Multiple R 0.386732661 R Square 0.149562151 Adjusted R Square 0.13489943 Standard Error 0.085231014 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.074097307 0.074097307 10.20016313 0.002270781

Residual 58 0.421330889 0.007264326 Total 59 0.495428196 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005944851 0.011068089 0.53711627 0.593241965 -0.016210336 0.028100038 -0.016210336 0.028100038 X Variable 1 1.023362125 0.320424548 3.193769423 0.002270781 0.381962709 1.664761541 0.381962709 1.664761541

104
SUMMARY OUTPUT Regression Statistics Multiple R 0.383509939 R Square 0.147079873 Adjusted R Square 0.128538131 Standard Error 0.080195712 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.051015836 0.051015836 7.932365467 0.00712947 Residual 46 0.2958422 0.006431352 Total 47 0.346858036 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000393806 0.012311057 0.031987973 0.974620036 -0.024387067 0.025174678 0.024387067 0.025174678 X Variable 1 1.507907888 0.535393945 2.816445538 0.00712947 0.430215789 2.585599986 0.430215789 2.585599986 SUMMARY OUTPUT Regression Statistics Multiple R 0.163462104 R Square 0.026719859 Adjusted R Square 0.001906027 Standard Error 0.066683295 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.004150585 0.004150585 0.93341596 0.340799124 Residual 34 0.151186504 0.004446662 Total 35 0.155337089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003675764 0.011497046 0.319713764 0.751141677 0.019689044 0.027040572 0.019689044 0.027040572 X Variable 1 0.533706226 0.552413977 0.966134545 0.340799124 0.588934039 1.656346491 0.588934039 1.656346491

105
SUMMARY OUTPUT Regression Statistics Multiple R 0.069278346 R Square 0.004799489 Adjusted R Square 0.040436898 Standard Error 0.079167201 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.000664963 0.000664963 0.106097978 0.747708888 Residual 22 0.137883804 0.006267446 Total 23 0.138548767 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003756989 0.017224404 0.218120123 0.829346055 0.031964238 0.039478216 0.031964238 0.039478216 X Variable 1 0.283154635 0.869300885 0.325726846 0.747708888 -

1.519665049 2.08597432 1.519665049 2.08597432

6 Month

SUMMARY OUTPUT Regression Statistics Multiple R 0.437891034 R Square 0.191748558 Adjusted R Square 0.180202109 Standard Error 0.090986791 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.137480264 0.137480264 16.60671217 0.000119689 Residual 70 0.579501734 0.008278596 Total 71 0.716981999 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00841056 0.010725208 0.784186213 0.435576501 -0.012980192 0.029801312 -0.012980192 0.029801312 X Variable 1 1.198420355 0.294081258 4.075133393 0.000119689 0.611893788 1.784946922 0.611893788 1.784946922 SUMMARY OUTPUT SUMMARY OUTPUT Regression Statistics Multiple R 0.387048161 R Square 0.149806279 Adjusted R Square 0.135147767 Standard Error 0.085218779 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.074218255 0.074218255 10.21974635 0.002250409 Residual 58 0.421209941 0.00726224 Total 59 0.495428196 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006066834 0.01106234 0.548422289 0.58550685 -0.016076845 0.028210513 -0.016076845 0.028210513 X Variable 1 1.024101022 0.320348534 3.196833801 0.002250409 0.382853765 1.665348278 0.382853765 1.665348278

106
Regression Statistics Multiple R 0.384170707 R Square 0.147587132 Adjusted R Square 0.129056418 Standard Error 0.080171861 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.051191783 0.051191783 7.964459871 0.007022773 Residual 46 0.295666253 0.006427527 Total 47 0.346858036 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000605378 0.012279655 0.049299284 0.960894229 -0.024112284 0.025323041 -0.024112284 0.025323041 X Variable 1 1.508855636 0.534649943 2.822137465 0.007022773 0.432661135 2.585050136 0.432661135 2.585050136 SUMMARY OUTPUT Regression Statistics Multiple R 0.164654568 R Square 0.027111127 Adjusted R Square -0.001503252 Standard Error 0.06666989 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.004211363 0.004211363 0.947465153 0.337239999 Residual 34 0.151125726 0.004444874 Total 35 0.155337089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003750672 0.01146997 0.326999293 0.745673146 -0.019559111 0.027060455 -0.019559111 0.027060455 X Variable 1 0.537149552 0.55184053 0.973378217 0.337239999 -0.58432533 1.658624433 -0.58432533 1.658624433 SUMMARY OUTPUT Regression Statistics Multiple R 0.071043761 R Square 0.005047216 Adjusted R Square -0.040177911 Standard Error 0.079157347 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.000699286 0.000699286 0.11160203 0.74149115 Residual 22 0.137849482 0.006265886 Total 23 0.138548767 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003749872 0.017178783 0.218285103 0.829219103 -0.031876742 0.039376487 -0.031876742 0.039376487 X Variable 1 0.290232311 0.868779796 0.3340689 0.74149115 -1.511506702 2.091971324 -1.511506702 2.091971324

107 2 Year
SUMMARY OUTPUT

Regression Statistics Multiple R 0.437022633 R Square 0.190988782 Adjusted R Square 0.179431478 Standard Error 0.091029546 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.136935518 0.136935518 16.52537617 0.000123908 Residual 70 0.58004648 0.008286378 Total 71 0.716981999 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.008866941 0.010728509 0.826484043 0.411337865 -0.012530394 0.030264276 -0.012530394 0.030264276 X Variable 1 1.194278879 0.293785309 4.065141593 0.000123908 0.608342564 1.780215195 0.608342564 1.780215195 SUMMARY OUTPUT Regression Statistics Multiple R 0.386802591 R Square 0.149616244 Adjusted R Square 0.134954456 Standard Error 0.085228303 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.074124106 0.074124106 10.20450134 0.002266251 Residual 58 0.42130409 0.007263864 Total 59 0.495428196 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.0063934 0.011053424 0.578408994 0.565227312 -0.015732433 0.028519233 -0.015732433 0.028519233 X Variable 1 1.021775626 0.319859788 3.194448519 0.002266251 0.381506701 1.662044552 0.381506701 1.662044552 SUMMARY OUTPUT Regression Statistics Multiple R 0.385363478 R Square 0.14850501 Adjusted R Square 0.129994249 Standard Error 0.080128685 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.051510156 0.051510156 8.022631427 0.006833677 Residual 46 0.29534788 0.006420606 Total 47 0.346858036 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000966055 0.012226892 0.079010639 0.937366879 -0.023645402 0.025577511 -0.023645402 0.025577511 X Variable 1 1.512916823 0.534141882 2.832425008 0.006833677 0.437744998 2.588088649 0.437744998 2.588088649

108
SUMMARY OUTPUT Regression Statistics Multiple R 0.167397983 R Square 0.028022085 Adjusted R Square -0.000565501 Standard Error 0.06663867 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.004352869 0.004352869 0.980218652 0.329138808 Residual 34 0.15098422 0.004440712 Total 35 0.155337089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003797349 0.011441711 0.331886479 0.742012282 -0.019455005 0.027049703 -0.019455005 0.027049703 X Variable 1 0.544678083 0.550146582 0.990059923 0.329138808 -0.573354282 1.662710448 -0.573354282 1.662710448 SUMMARY OUTPUT Regression Statistics Multiple R 0.076221685 R Square 0.005809745 Adjusted R Square -0.039380721 Standard Error 0.079127008 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.000804933 0.000804933 0.128561304 0.723346262 Residual 22 0.137743834 0.006261083 Total 23 0.138548767 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00359244 0.017186825 0.209022878 0.83635368 -0.032050853 0.039235733 -0.032050853 0.039235733 X Variable 1 0.311040141 0.867483666 0.358554464 0.723346262 -1.488010863 2.110091145 -1.488010863 2.110091145

5 Year
SUMMARY OUTPUT Regression Statistics Multiple R 0.436041577 R Square 0.190132257 Adjusted R Square 0.178562718 Standard Error 0.091077721 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.136321406 0.136321406 16.43386603 0.000128839

Residual 70 0.580660593 0.008295151 Total 71 0.716981999 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.009573166 0.010733797 0.891871344 0.375517483 -0.011834717 0.030981049 -0.011834717 0.030981049 X Variable 1 1.19052507 0.293676147 4.0538705 0.000128839 0.60480647 1.776243669 0.60480647 1.776243669

109
SUMMARY OUTPUT Regression Statistics Multiple R 0.385788312 R Square 0.148832622 Adjusted R Square 0.134157322 Standard Error 0.085267563 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.073735877 0.073735877 10.14170924 0.002332744 Residual 58 0.421692318 0.007270557 Total 59 0.495428196 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006950186 0.011043416 0.629351098 0.531590467 -0.015155613 0.029055985 -0.015155613 0.029055985 X Variable 1 1.018364892 0.319777454 3.184605037 0.002332744 0.378260776 1.658469008 0.378260776 1.658469008 SUMMARY OUTPUT Regression Statistics Multiple R 0.384352295 R Square 0.147726687 Adjusted R Square 0.129199006 Standard Error 0.080165298 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.051240188 0.051240188 7.973296219 0.006993695 Residual 46 0.295617848 0.006426475 Total 47 0.346858036 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.001607214 0.012163928 0.132129505 0.895458121 -0.022877503 0.02609193 -0.022877503 0.02609193 X Variable 1 1.512615632 0.535685184 2.823702573 0.006993695 0.4343373 2.590893965 0.4343373 2.590893965 SUMMARY OUTPUT Regression Statistics Multiple R 0.167435662 R Square 0.028034701 Adjusted R Square -0.000552514 Standard Error 0.066638238 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.004354829 0.004354829 0.980672692 0.329028391 Residual 34 0.15098226 0.004440655 Total 35 0.155337089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003906649 0.011415474 0.342223966 0.734288894 -0.019292385 0.027105682 -0.019292385 0.027105682 X Variable 1 0.544050983 0.549385962 0.990289196 0.329028391 -0.572435616 1.660537583 -0.572435616 1.660537583

110
SUMMARY OUTPUT Regression Statistics Multiple R 0.077490443 R Square 0.006004769 Adjusted R Square -0.039176833 Standard Error 0.079119247 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.000831953 0.000831953 0.132902965 0.718921732 Residual 22 0.137716814 0.006259855 Total 23 0.138548767 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00355091 0.017191212 0.206553818 0.838258026 -0.032101481 0.039203302 -0.032101481 0.039203302 X Variable 1 0.316183885 0.867306089 0.36455859 0.718921732 -1.482498847 2.114866617 -1.482498847 2.114866617

10 Year

SUMMARY OUTPUT Regression Statistics Multiple R 0.435697218 R Square 0.189832066 Adjusted R Square 0.178258238 Standard Error 0.0910946 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.136106174 0.136106174 16.40183969 0.000130612 Residual 70 0.580875825 0.008298226 Total 71 0.716981999 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.01012926 0.010737471 0.943356229 0.348743333 -0.01128595 0.031544469 -0.01128595 0.031544469 X Variable 1 1.189664311 0.293750187 4.04991848 0.000130612 0.603798044 1.775530578 0.603798044 1.775530578 SUMMARY OUTPUT

Regression Statistics Multiple R 0.385301963 R Square 0.148457603 Adjusted R Square 0.133775837 Standard Error 0.085286345 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.073550082 0.073550082 10.11169963 0.00236524 Residual 58 0.421878114 0.007273761 Total 59 0.495428196 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007427615 0.011034922 0.673100803 0.503556421 -0.014661182 0.029516412 -0.014661182 0.029516412 X Variable 1 1.01698019 0.319816166 3.179889877 0.00236524 0.376798583 1.657161797 0.376798583 1.657161797

111
SUMMARY OUTPUT Regression Statistics Multiple R 0.383430821 R Square 0.147019195 Adjusted R Square 0.128476134 Standard Error 0.080198564 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.050994789 0.050994789 7.928528899 0.007142339 Residual 46 0.295863247 0.00643181 Total 47 0.346858036 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002198057 0.012108544 0.181529438 0.856749571 -0.022175177 0.026571291 -0.022175177 0.026571291 X Variable 1 1.511944215 0.536956941 2.815764354 0.007142339 0.431105968 2.592782462 0.431105968 2.592782462 SUMMARY OUTPUT Regression Statistics Multiple R 0.167299661 R Square 0.027989176 Adjusted R Square -0.000599377 Standard Error 0.066639798 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.004347757 0.004347757 0.979034364 0.329427052 Residual 34 0.150989332 0.004440863 Total 35 0.155337089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.004033295 0.011387311 0.354192039 0.72538225 -0.019108506 0.027175096 -0.019108506 0.027175096 X Variable 1 0.543318167 0.549104824 0.989461653 0.329427052 -0.57259709 1.659233423 -0.57259709 1.659233423 SUMMARY OUTPUT Regression Statistics Multiple R 0.077998405 R Square 0.006083751 Adjusted R Square -0.03909426 Standard Error 0.079116103 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.000842896 0.000842896 0.134661775 0.717152766 Residual 22 0.137705871 0.006259358 Total 23 0.138548767 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003559351 0.017169595 0.207305462 0.837678188 -0.032048209 0.03916691 -0.032048209 0.03916691 X Variable 1 0.318375148 0.867594906 0.366962907 0.717152766 -1.480906553 2.117656849 -1.480906553 2.117656849

112

References

1. www.dollargeneral.com Dollar General 10-K 2. www.familydollar.com Family Dollar 10-K 3. www.dollartree.com Dollar Tree 10-K 4. www.edgarscan.com 5. www.finance.yahoo.com 6. www.nyse.com 7. http://moneycentral.msn.com 8. www.research.stlouisfed.org/fred2/

9. Bernard, Victor, Paul Healy, and Krishna Palepu. Business Analysis & Valuation Third Edition. 2004