Dollar General 2009 Annual Report Download - page 65

income, and at the communication date for severance and other exit costs. Key assumptions in
calculating the liability include the timeframe expected to terminate lease agreements, estimates related
to the sublease potential of closed locations, and estimation of other related exit costs. Historically,
these estimates have not been materially inaccurate; however, if actual timing and potential termination
costs or realization of sublease income differ from our estimates, the resulting liabilities could vary
from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
Share-Based Payments. Our share-based stock option awards are valued on an individual grant
basis using the Black-Scholes-Merton closed form option pricing model. We believe that this model
fairly estimates the value of our share-based awards. The application of this valuation model involves
assumptions that are judgmental and highly sensitive in the valuation of stock options, which affects
compensation expense related to these options. These assumptions include an estimate of the fair value
of our common stock, the term that the options are expected to be outstanding, an estimate of the
volatility of our stock price (which is based on a peer group of publicly traded companies), applicable
interest rates and the dividend yield of our stock. Our volatility estimates are based on a peer group
due to the fact that our stock was publicly traded for only a small portion of our most recently
completed fiscal year. Other factors involving judgments that affect the expensing of share-based
payments include estimated forfeiture rates of share-based awards. Historically, these estimates have
not been materially inaccurate; however, if our estimates differ materially from actual experience, we
may be required to record additional expense or reductions of expense, which could be material to our
future financial results.
Fair Value Measurements. We measure fair value of assets and liabilities in accordance with
applicable accounting standards, which require that fair values be determined based on the assumptions
that market participants would use in pricing the asset or liability. These standards establish a fair value
hierarchy that distinguishes between market participant assumptions based on market data obtained
from sources independent of the reporting entity (observable inputs that are classified within Levels 1
and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant
assumptions (unobservable inputs classified within Level 3 of the hierarchy). Therefore, Level 3 inputs
are typically based on an entity’s own assumptions, as there is little, if any, related market activity, and
thus require the use of significant judgment and estimates. Currently, we have no assets or liabilities
that are valued based solely on Level 3 inputs.
Our fair value measurements are primarily associated with our derivative financial instruments,
intangible assets, property and equipment, and to a lesser degree our investments. The values of our
derivative financial instruments are 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. In recent years, these methodologies have produced materially accurate valuations.
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