Dollar General 2008 Annual Report Download - page 78

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Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or
liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted
prices included in Level 1 that are directly or indirectly observable for the asset or liability. Level
2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as
inputs that are observable for the asset or liability (other than quoted prices), such as interest
rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs for the asset or liability, which are based on an entity’ s
own assumptions, as there is little, if any, related market activity. In instances where the
determination of the fair value measurement is based on inputs from different levels of the fair
value hierarchy, the level in the fair value hierarchy within which the entire fair value
measurement falls is based on the lowest level input that is significant to the fair value
measurement in its entirety. The Company’ s assessment of the significance of a particular input
to the fair value measurement in its entirety requires judgment and considers factors specific to
the asset or liability.
The valuation of the Company’ s derivative financial instruments is determined using
widely accepted valuation techniques, including discounted cash flow analysis on the expected
cash flows of each derivative. This analysis reflects the contractual terms of the derivatives,
including the period to maturity, and uses observable market-based inputs, including interest rate
curves. The fair values of interest rate swaps are determined using the market standard
methodology of netting the discounted future fixed cash payments (or receipts) and the
discounted expected variable cash receipts (or payments). The variable cash receipts (or
payments) are based on an expectation of future interest rates (forward curves) derived from
observable market interest rate curves.
To comply with the provisions of SFAS 157, the Company incorporates credit valuation
adjustments (CVAs) to appropriately reflect both its own nonperformance risk and the respective
counterparty’ s nonperformance risk in the fair value measurements. In adjusting the fair value of
its derivative contracts for the effect of nonperformance risk, the Company has considered the
impact of netting and any applicable credit enhancements, such as collateral postings, thresholds,
mutual puts, and guarantees.
Although the Company has determined that the majority of the inputs used to value its
derivatives fall within Level 2 of the fair value hierarchy, the CVAs associated with its
derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the
likelihood of default by itself and its counterparties. However, as of January 30, 2009, the
Company has assessed the significance of the impact of the CVAs on the overall valuation of its
derivative positions and has determined that the CVAs are not significant to the overall valuation
of its derivatives. Based on the Company's review of the CVAs by counterparty portfolio, the
Company has determined that the CVAs are not significant to the overall portfolio valuations, as
the CVAs are deemed to be immaterial in terms of basis points and are a very small percentage
of the aggregate notional value. Although some of the CVAs as a percentage of termination
value appear to be more significant, primary emphasis was placed on a review of the CVA in
basis points and the percentage of the notional value. As a result, the Company has determined
that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.