Family Dollar Stores, Inc. Equity Valuation and Analysis

*As of November 1, 2007*

A Fundamental Study by:

Cody Baker [email protected] Nolan Bosworth [email protected] Ryan Huff [email protected] Denyel Johnston [email protected] T.J. Randolph [email protected]

Table of Contents

Executive Summary 3

Business and Industry Analysis 9

Company Overview 9

Industry Overview 10

Five Forces Model 12

Rivalry Among Existing Firms 13

Threat of New Entrants 19

Threat of Substitute Products 21

Bargaining Power of Customers 21 Bargaining Power of Suppliers 24 Value Chain Analysis 25 Firm Competitive Advantage Analysis 29 Accounting Analysis 34 Key Accounting Policies 35 Potential Accounting Flexibility 38 Actual Accounting Strategy 42 Quality of Disclosure 45 Qualitative 45 Quantitative (Screening Ratios) 47 Revenue Diagnostics 47 Expense Diagnostics 48 Potential “Red Flags” 53 Undo Accounting Distortions 53

Financial Analysis 56 Liquidity Ratios 57 Profitability Ratios 69 Capital Structure Ratios 79 Financial Statement Analysis 87 Income Statement 88 Balance Sheet 91 Statement of Cash Flows 94 Estimate Cost of Capital 96 Cost of Equity 96 Cost of Debt 98 Weighted Average Cost of Capital 99 Analysis of Valuation 101 Method of Comparables 102 Intrinsic Valuations Methods 109 Discounted Dividends Model 110 Free Cash Flow Model 111 Residual Income Model 113 Long Run Return on Equity Residual Income Model 114 Abnormal Earnings Growth Model 116 Credit Analysis 118 Analyst Recommendation 120 Appendices 121 References 148

Executive Summary

Investment Recommendation: UNDERVALUED, BUY (11/1/2007)

FDO – NYSE (11/1/2007): $23.24 Altman Z-score 52 Week Change: $21.03 - $35.42 2002 2003 2004 2005 2006 Revenue: $6.83B 9.20 10.46 7.24 6.10 5.77 Market Capitalization: $3.27B Shares Outstanding: 140.47M Valuation Estimates Percent Institutional Ownership: 107% Actual Price (11/1/07): $23.24 Book Value per Share: $8.195 ROE: 13.66% ROA: 8.10% Financial Based Valuations Trailing P/E: $60.65 Cost of Capital Est. R² Beta Ke Forward P/E: $31.14 Estimate: PEG: $22.09 3-month .1046 .75 10.12% P/B: $15.31 1-year .1050 .75 10.12% P/EBITDA: $37.86 2-year .1052 .75 10.11% P/FCF: $37.86 5-year .1053 .75 10.11% EV/EBITDA: $31.85 7-year .1052 .75 10.10% Intrinsic Valuations Discounted Dividends: $16.82 Free Cash Flows: $70.23 Published Beta: 1.01 Residual Income: $31.62 Kd(BT): 10.11% LR ROE: $11.62 WACC(BT): 4.724% WACC(AT): 7.95% AEG: $27.21

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Industry Analysis Established in Charlotte, North Carolina, Family Dollar has competed in the discount store industry since 1959. North Carolina has remained the headquarters of the company since opening, and distribution centers are located in many states including: Arkansas, Kentucky, Oklahoma, Virginia, Iowa, Florida, and Texas. Currently there are over 6200 Family Dollar retail stores in 44 different states throughout the country, all of which are geared towards low to lower middle class income consumers (Family Dollar 10k). Most of the stores are leased property and are smaller in size for the purpose of quick, easy opening in populated and rural areas. Family Dollar’s three main competitors are: The Dollar Tree, The Dollar General, and 99 Cent Only. Wal-mart and Target are also classified in the discount store industry, but are not direct competitors to Family Dollar. Family Dollar and its competitors compete on price, rather than quality. Each store offers generic and name brand products at discount prices. All stores sell nothing over 10 dollars and are geared towards lower to middle lower class families. Each of the companies are constantly opening new stores is neighborhood shopping centers in order to gain market share and be more convenient for customers. Convenience is important in this industry because, customers will most likely not pass one store up to go to another. There are many things that drive the industry, which are known as the rivalry among existing firms. The industry has little consumer loyalty because the products are undifferentiated, so the threat of substitute products is extremely high. There is little threat of new entrants, due to the relationships established with suppliers and low cost distributions. The bargaining power of customers is moderate and the bargaining of suppliers is very low. The prices are already discounted and the products are undifferentiated, so there is no room left for suppliers or customers to bargain for lower prices.

The key success factors for the industry include: low cost distribution, economies of scale, and tight cost control. By buying in mass quantity and using the relationships with suppliers to obtain product for low costs, enables the industry to offer the lowest prices. There is little advertisement within the industry except for news paper fillers and other low cost ads, to keep the expenses down, in turn keeping prices and costs low. Low prices and market share are key success factors in this industry.

Accounting Analysis A firm’s accounting policies are very important to understand in order to be able to make accurate assumptions in the valuation process. (GAAP) allows companies to be flexible in the way that they report their numbers and disclose certain information. This creates many different creative accounting strategies that vary from company to company. By going through and analyzing the firm’s financial statements, the level of disclosure and accuracy is revealed. Accounting analysis will also reveal any potential “Red Flags” in the company’s disclosure. Family Dollar’s key success factors, as identified in the Firm Competitive Advantage Analysis, are economies of scale, reduced input costs, low-cost distribution, and a tight cost control system. This emphasis on cost leadership creates the following Key Accounting Policies for the discount store industry: lease treatment, merchandise inventories, intangible assets (particularly goodwill), and employee retirement programs. The emphasis on minimizing costs can be seen throughout the financial statements. The increase of revenue can also be observed, in large part from the increase in stores and market share. With flexibility in the (GAAP) policies, there is plenty of room to cover less attractive financial data. Family Dollar is very open about all financial data and implements the use of notes and descriptions explaining the numbers reported in the financial statements. For the most part, Family Dollar’s reporting is very transparent and easy to follow and expresses a level of disclosure. Family Dollar is overall conservative when it comes to their accounting strategies.

A potential “RED Flag” that was uncovered was the way Family Dollar’s operating leases where disclosed. When companies use and record operating leases, they are usually only occupying the location for three to five years. When using an operating lease, financial statements only show it as an expense depreciated on a straight-line basis. After the time allocated, the company can choose to renew their lease with the lessor. So, the company could end up using the building for all of its useful life after all. This should then be recorded as a capital lease, but isn’t with Family Dollar, which is a red flag for the company.

Financial Analysis, Forecast Financials, & Cost of Capital Estimation An important part in valuing a firm is looking at a company’s liquidity, capital structure, and profitability. These calculations are found by computing a series of ratios for each item listed above. The firm’s financial statements are then forecasted out using these ratios to predict future performance of the firm and then compared to the rest of the industry. After this, a regression model is formed to calculate beta, weighted average cost of capital, and cost of equity. Family Dollar has descent liquidiity compared to the rest of the industry. The liquidity is found by calculating numerous ratios. This assesses the firm’s ability to pay off short term debt obligations, which is also a very important part in valuing a firm. Family Dollar outperforms its competitors or the industry average in all ratios except the Current Ratio and the Inventory Turnover Ratio. Family Dollar shows weakness in these two categories but, demonstrates its strength in its Days Supply Turnover and its Working Capital Turnover. Profitability is also calculated through a series of ratios. Family Dollar is struggling in this area when compared to its competitors. FDO had consecutive decreases across the board in all ratios except for Asset Turnover and Gross Profit Margin. When compared to the rest of the industry and FDO’s competitors, this is a poor performance. With this being said, even with the decreasing ratio percentages, FDO still beat the industry average in every profitability ratio except Operating Profit Margin. The Family Dollar, even though beating industry

average, is performing poorly, in context to profitability ratios, when compared to its competitors. The Capital Structure Ratios are important to find out how much of the firm is financed by debt and equity. Family Dollar is doing well in regards to its capital structure. There is a healthy amount of financing going on with debt and equity and the company can sustain more growth than the current growth rate. When compared to its competitors, Family Dollar is performing well in this area. After forecasting FDO’s financial statements, it is fair to say that there is a steady increase across the board, which would indicate that the company is growing. The company shows growth in assets, net income, sales, and many other areas.

Valuations The valuations methods are possible only after all of the above ground work has been completed. These valuation models ultimately tell investors whether or not to invest in Family Dollar so getting these models unbiased and correct is the main purpose of the entire valuation project. It is also the reason why two different valuation classes are utilized: the comparables methods and the intrinsic valuation methods. The comparables methods are done as preliminary valuations because they are not based on solid financial theory. Most require the computation of an industry average and then use this average to attain an estimated share price for the firm being valued. As you can see in FDO’s case these estimations vary significantly from a low of $15.31/share to a high of $60.65/share. All but two of these comparables valuations show FDO’s share price to be undervalued. The PEG and P/B ratios are the only methods that show any overvaluation. Even despite that most show FDO is undervalued, because of the wide range of share price estimations and their lack of financial theory, the comparables methods should never alone be used to value a company. They should be used as loose guidelines that supplement the theory based valuation models.

The intrinsic valuation models are based on financial theory and thus, a much stronger representation of the true share price. They are based on data that was forecast from historical numbers for firm being valued. Of our intrinsic valuation models three out of five show Family Dollar to undervalued. The Discounted Dividends Model and Long Run ROE Model are the only two that show FDO as overvalued. We considered the DD Model to be inaccurate because it uses forecasted cash flows which are notoriously difficult predict. Residual Income shows an undervalued share price and this model is much more reliable because it is derived from earnings, dividends, and the book value of equity. The Abnormal Earnings Growth Model also shows a fair to slightly undervalued price and this model is based on the RI Model which uses more accurately forecasted metrics. As stated before, the Free Cash Flow Model is effectively useless do to the difficulty in forecasting cash flows.

Business and Industry Analysis

Company Overview

The Family Dollar is in the economic sector known as the discount store industry. Established in November of 1959, in Charlotte, North Carolina, The Family Dollar has evolved into one of the premier discount stores in the United States. North Carolina has remained the headquarters of the company since opening, and distribution centers are located in many states including: Arkansas, Kentucky, Oklahoma, Virginia, Iowa, Florida, and Texas. Currently there are over 6200 Family Dollar retail stores in 44 different states throughout the country, all of which are geared towards low to lower middle class income consumers (Family Dollar 10k). Most of the stores are leased property and are smaller in size for the purpose of quick, easy opening in populated and rural areas. Each store carries a variety of both generic and nationally advertised, name brand household and family goods. Most of the products in the store are priced less than ten dollars in large part because of very low overhead and the implementation of self-service. Higher product costs are also avoided by keeping advertising costs at a minimum. Most of the Family Dollar advertising is conducted through circulars inserted in the news paper or mailed directly to potential customers. With the opening of 350 new stores and a 570 million dollar increase in sales in the fiscal year 2006, Family Dollar is showing consistency in sales increases in the past three years but, is opening fewer stores going from 500 the past 2 years to 350 in 2006.

Family Dollar 2002 2003 2004 2005 2006 Net Sales (thousands) $4,162,652 $4,750,171 $5,281,888 $5,824,808 $6,394,772 % Change 13.57% 14.11% 11.19% 10.28% 9.79% Total Assets (thousands) $1,754,619 $1,985,695 $2,224,361 $2,409,501 $2,523,029 % Change 25.35% 13.17% 12.02% 8.32% 4.71% Stock Price $28.55 $40.12 $26.45 $19.88 $25.57 % Change 6.45% 40.53% -34.07% -24.84% 28.62%

Industry Overview

The discount store industry is a very competitive market with many legitimate companies. The largest stores in the discount category are Wal-mart and Target. Wal-Mart dominates the industry, making 612.4 billion dollars in sales in the fiscal year 2006, while Target made 51.6 billion dollars in sales. It is clear that these two companies set the standard in the discount store industry, but they are not considered direct competitors to the Family Dollar. Where Wal- Mart and Target focus on providing customers with a larger variety of better quality of goods, the Family Dollar and its direct competitors focus more on low prices and the selling of mostly inferior goods. Three of the direct competitors of the Family Dollar include: The Dollar Tree, The Dollar General, and 99 Cents stores. The Dollar Tree and The Dollar General are the company’s biggest competitors. The Dollar General made 8.5 billion dollars in sales in 2006, making it the biggest competitor to The Family Dollar. The Dollar Tree brought in 3.9 billion dollars in sales, and the Family Dollar made 6.3 billion dollars in sales in the fiscal year 2006. The 99 Cents Store, a much smaller company, only made about 1 billion dollars in sales in 2006. All the companies experienced an increase in sales and an increase in the number of stores being opened. The Dollar Tree opened 305 new stores, The Dollar General opened 300 new stores,

the 99 Cents Only Store opened 251 new stores, and the Family Dollar opened 350 new stores in the fiscal year 2006. The main competitive factors driving the competition for customers in this industry are: price, location, customer service, in- stock consistency, and presentation (Family Dollar 10k). With each company opening new stores and sales sky rocketing, the industry appears to be growing rapidly.

Comparison 2002-2003 2003-2004 2004-2005 2005-2006 Company Average Family Dollar % Sales Growth 14.11% 11.19% 10.28% 9.79% 11.34% % Asset Change 13.17% 12.02% 8.32% 4.71% 9.56% Dollar Tree % Sales Growth 20.21% 11.65% 8.57% 16.96% 14.35% % Asset Change 32.60% 21.10% 0.32% 4.16% 14.55% Dollar General % Sales Growth 12.35% 8.39% 4.90% 2.02% 6.92% % Asset Change 12.66% 11.48% 12.03% 6.85% 10.75% 99 Cents Only % Sales Growth 22.95% 13.91% 18.43% % Asset Change 25.00% 8.49% 16.75% Industry Average % Sales Growth 17.40% 11.29% 7.92% 9.59% 12.76% % Asset Change 20.86% 13.27% 6.89% 5.24% 12.90%

2006 Locations Family Dollar Dollar Tree Dollar General 99 Cents Only Stores Opened 305 305 300 251 Total Existing 6208 3217 8229 483

The Five Forces Model

Michael Porter developed an analytic tool, now known as “the five forces model”, to analyze and asses the value of an industry. The five forces model utilizes an outside looking in view of a corporation’s or business organization’s industrial environment to derive a conclusion of value from five different driving forces. These forces include: rivalry among existing firms, threat of new entrants, threat of substitute products, bargaining power of customers, and bargaining power of suppliers. The first three forces valuate the degree of actual competition along with potential competition. These forces are useful in predicting whether or not there is a market for potential deviant profits. The bargaining power in input and output markets is analyzed through the later two forces. These forces influence the actual profits versus potential profits. When information of an industry is obtained and examined using the five forces model, a firm can more easily strategize and plan for growth within the industry.

DISCOUNT VARIETY STORE INDUSTRY Rivalry Among Existing Firms Very High Threat of New Entrants Very Low Threat of Substitute Products High Bargaining Power of Customers Moderate Bargaining Power of Suppliers Low

Rivalry Among Existing Firms

The intensity of competitive rivalry in an industry is determined by a number of circumstances and varies from industry to industry. Firms in any industry desire a competitive advantage over its competitors to get ahead. Cost advantage and differentiation advantage are the two types of competitive advantage. Differentiation advantage is concerned with producing benefits in product quality that surpass the rival’s products in order to gain an edge. In the discount variety store industry, firms focus on cost leadership because cost, not quality, is the costumer’s concern. Achieving a cost leadership competitive advantage in this industry will generate deviant profits for the firm while charging the same price as competitors. The rivalry among competitive firms can be evaluated by these following industry characteristics (quickmba.com).

Industry Growth Rate The discount retail industry is a very strong and established sector of the U.S. economy. Our research would suggest that there has been a considerable growth in the industry since 2002. The Family Dollar, Dollar General, Dollar Tree, and 99 Cents Only went from a combined total in sales in 2002 of over 15 billion dollars, to a combined total in sales of over 20 billion dollars in 2006. Each company has also acquired more assets in large part due to the opening of a combined total of 6157 stores since 2002. Most of the industry focuses on low prices and is geared more towards low to lower middle class consumers. The increase of immigration into the United States in recent years has increased the number of consumers that are in these socio-economic classes thus provided more customers for the industry.

Such a large inflow of new consumers can be partially contributed to the substantial increase in sales over the past five years and in years to come. Each of the four companies researched have predicted an increase in sales for 2007 and are in the process of opening new stores throughout the U.S. The data analyzed would suggest that the discount store industry is growing steadily, and shows no signs of downsizing any time soon. Firms’ competing for market share in the due to industry growth is one aspect of the rivalry amongst the existing variety discount stores.

The Sales Growth Chart was derived from the annual net sales reported by each company in their respective 10-Ks. The amount of growth may have slumped slightly, but overall this is a very healthy increase in sales for each company and the industry as a whole. 99 Cent Only had a change in fiscal year end and chose not to disclose enough financial data to determine an accurate

net sales growth.

The Asset Growth Chart illustrates there is a small difference between companies’ assets. The percentage growth is derived from each companies reported total assets on their balance sheets. This percentage change can give a general idea of a company’s growth. However, in the retail industry, a large portion of a company’s assets is comprised of merchandise inventory. This value estimate can change drastically and be altered in a number of ways for many reasons. Nevertheless, the industry average shows a healthy growth slowing down from the boom in 2002-2003. Once again, 99 Cent Only Store did not provide adequate information to derive an accurate percentage

Concentration The relative sizes and number of firms in an industry, in relation to that industry as a whole, is measured by the concentration ratio. The market form of an industry is indicated by the concentration ratio. The discount variety store

industry is an oligopoly market structure similar to that of the automobile industry. This is true because the concentration ratio shows that the industries 4 largest firms (Dollar General, Family Dollar, 99 Cent Only, and Dollar Tree) own more than 40 % of the market share (10 K’s of each firm). When a few number of firms own such a big portion of the market, that industry is said to be highly concentrated. At this level of concentration, firms must and will compete for success.

Market Share

The percentages displayed in these graphs were derived from the net sales reported by Family Dollar, Dollar Tree, Dollar General, and 99 Cents Only Store. It was not possible to compute an accurate market share for the year of 2005 because 99 Cents Only Store changed their fiscal year end. Additionally, they did not disclose enough financial data to estimate their 2005 net sales.

Differentiation When firms of an industry have low levels of product differentiation, competition is more intense. If products and services, in an industry, are similar or not differentiated, rivalry levels among existing firms are elevated. There is little to no differentiation among products in the variety discount store industry. Customers will jump from competitor to competitor to get there product because there is not much product or price contrasts. If differentiation is absent, firms’ competing for customers is present.

Switching costs When product differentiation is minimal, switching business from one supplier to another is less expensive. The switching costs in the variety, discount store industry, pertaining to the use of assets for alternative purposes, are relatively low. Although very unlikely, a discount store could liquidate inventory and use store space to sell auto parts, shoes or anything of the retail nature. With store space that is already suited for selling “stuff”, switching costs are minimal in that aspect.

Ratio of Fixed to Variable Costs Fixed costs are costs that remain constant despite revenue earned. A fixed cost could be wages that must be paid to employees running a firm even if the firm’s sales dollars for the day are zero. Regardless of the revenue the employees must be paid. Variable costs are expenses that vary, hence the name variable, with the amount of revenues generated. Commissions on sales are a prime example of a variable cost. If an employee sales 100 dollars worth of product and earns 10% commission, then the firm must pay the employee 10 dollars. Those ten dollars is a variable cost (expense) to the firm. If the employee sells 200 dollars worth

of product, the firm will have a commission expense of 20 dollars which will be paid to the employee. When fixed costs are high and variable costs low the ratio of fixed costs to variable costs is high. High fixed costs will cause a firm to operate at full capacity to generate enough revenue to cover these fixed costs. When fixed costs are diversified among a large number of units, profits will increase because the cost of each unit will decrease. In the variety discount store industry firms are very cost competitive. Fixed costs are high in this industry because firms lease most of the company’s stores. Family Dollar leases 5,719 of its 6,208 stores (FDO 10k). “Most of Dollar General’s stores are located in leased premises” (DG 10k). Due to low prices firms attain profits by driving costs down. Firms keep costs low by selling large quantities (units) of products. This will diversify fixed costs. In industries where firms must operate close to full capacity, rivalry amongst the firms increases with the increased production output.

Excess Capacity and Exit Barriers When an industry becomes flooded with new entrants, competition among rival firms can cause supply to exceed the customer’s demand. If the market is saturated and the industry growth rate slows down, there will not be too many goods and not enough customers to consume the goods. This type of situation is known as excess capacity. This type of “industry shakeout” can be a death sentence to companies when exit barriers are high. Fortunately the variety discount store industry does not foresee new entrants as a potential threat. The degree of exit barriers in the industry determines the cost of liquidating the product and switching industries. High exit barriers will in turn cause firms to remain in the industry when profits are low are losses are incurred. Industries with specialized products experience high exit barriers where as it would not cost much for variety discount stores to liquidate products and switch industries (quickmba.com). Firms must compete when exit barriers

are high. Dollar Tree, Family Dollar, 99 Cents only, and Dollar General have been present in the industry and prospered for many years. Although the exit barriers in the variety discount store industry are relatively low, it is not probable that firms would exit the industry when historically, and in the fairly predictable future, there is no reason to. Thus, it is safe to state that because the firms are not exiting, rivalry remains high.

Conclusion After analyzing this industry through these different aspects, the data concludes that the variety, discount industry rivalry among existing firms is very intense. The intensity of the rivalry within the industry will continue to maintain an elevated level as each firm strives for a cost leadership competitive advantage over the other firms.

Threat of New Entrants

An industry with the potential to provide deviant profits will interest new entrants. The threat of new entrants can impact price limitations among established firms in easily accessible industries. Depending on several circumstances, entry into an existing firm can prove to be an easy task or an unattainable goal. The threat of new entrants into the discount variety store industry poses little threat on the industry.

Economies of Scale “An economy of scale characterizes a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit (www.wikipedia.com).” The existence of such an economy of scale is very beneficial to the variety discount store industry. Because of the large volume or bulk of product they purchase and sale over a long period of time,

costs per unit remain low. New entrants would experience difficulty in keeping prices as low as established firms because they would not have the resources to purchase on a large scale.

Access to Distribution Routes and Supplier Sources Discount variety store supplier relationships are scarce. The well established firms of the industry have attained contracts with suppliers making it difficult for new entrants to purchase products at such low prices. Suppliers agree to these contracts because they benefit from the amount of volume they are able to move. The buyers are able to consistently purchase massive quantities from suppliers for low costs which is good for both players. This proves to be a huge cost challenge for potentially new firms because of existing supplier – discount store relationships. If costs are high, prices will elevate in order to attain profits. Keeping costs down, which in turn keeps prices low, is essential for entrance and survival in this competitive industry.

Legal Barriers Complying with the laws is critical for entrance and prosperity in any industry. The degree of the laws can prove to be a significant barrier or a minor obstacle. Entrance into the discount variety store industry is not highly affected by government restrictions. This does not mean that it is not a potential obstacle for new entrants. A significant percentage of goods in the variety discount store industry are imported. New comers must be aware of tax laws such as those pertaining to imported goods which can negatively affect supply pricing. Again, keeping costs down is a must in this industry, thus increased costs are a handicap to entrance into the market.

Conclusion

Well established supplier relationships, large economy of scale, and a few legal barriers are all hurdles that keep the threat of new entrants into the industry low. Threat of Substitute Products

The threat of substitute products will always be of major concern to the variety discount store industry. The five direct competitors in the discount variety store industry practically offer all the same products with the same prices. As a result, customers switching cost would ultimately be low. These factors cause a huge threat of substitute products in the discount variety store industry.

Buyers Willingness to Switch Customers of the discount variety store industry are generally not partial to any particular discount store over another. Due to similar products and pricing throughout the industry, customers will shop by convenience. Although the targeted customer is loyal to the industry, they are more than willing to substitute one discount vendor for another. Because of this, firms must focus on store location in order to attract consumers.

Conclusion Disloyal customers and firms mirroring firms in the industry causes a significant threat of substitute products. Switching costs will always be low in this industry so the threat of customers substituting one store for another will always be a factor of the industry.

Bargaining Power of Customers

The fourth component of the Five Forces Model is the bargaining power of customers. This component explains the relationship between a specific industry and its customer. This relationship is essential. Depending on who has the

power over the other determines “who is boss” in the relationship. Customers have an impact on the industries behavior such as prices of products and the type of merchandise that the stores in the industry provides if they have power over the company. If it’s the other way around, the industry has power over the customer; the industry can charge any amount for the product they supply and chose any location to ground their stores. Who has this control is a key factor of how any industry operates its business and cost leadership strategies.

Switching Costs Dollar General, Wal-Mart, 99 Cent Only Stores, and Family Dollar are just some of the many discount variety stores in the United States. Many of these companies advertise “brand names” at “low prices” and this is just the case. Most merchandise supplied in discount stores is priced under or around ten dollars. Since there are so many of these low-end retail stores for a consumer to choose from, the industry is highly competitive. The price for a consumer to switch from a Dollar General Store to a Family Dollar store is practically nothing. Because of their similar product offering and price the primary factor in a customer choosing one store over another simply becomes location. The closer store the more ideal for the customer and would thus be chosen over a farther store.

Differentiation In the self-service discount retail industry, there is some degree of differentiation necessary to compete within any industry, but in the discount variety industry a strong cost leadership strategy is paramount. Though attracting a large volume of buyers is priority. The main way that general merchandisers try to differentiate themselves from other discount stores is by offering brand name products for their customers, such as Tide, General Mills Cereals, Johnson & Johnson, and Bounty, etc. Most companies in this industry have its own brand name that is available at lower cost than leading brands in

stock. Coming up with new way to put them apart from the rest is some consideration of how Family Dollar and other discount stores operate their business. Importance of Product for Costs and Quality The type of target market Family Dollar and other full-line discounters are interested in attracting is the “low to lower middle-income consumers” (Reuters). The quality of the product is not a huge impact on the decision of the consumer. However, cost of the product is an important criteria measure when customers are shopping in these low-end retail stores. Customers are more interested in how much they can get for their dollar. Private brand names that a store like Dollar General offers are at a lower cost for their consumers compared to more popular brands. DG Guarantee and Clover Valley are some of Dollar General Private brand labels. Many of the discount stores have their own private brands on their shelves.

Number of Customers The number of customers coming into these discount stores is very important. Discount stores place their buildings in areas where their customer lives. An important customer to Family Dollar is “women shopping for a family that earns around $25,000 a year” (Answers.com). The more stores a company has in their target market the easier it is to increase customer foot traffic. Dollar General leads the industry with about 8,200 stores in thirty-five states while 99 Cent Only Stores have only 251 stores in only four states (Hoover.com). In return, Dollar General has higher net sales than 99 Cent Only Stores since they are more available and convenient. Companies in this area try to come up with fresh new ideas to bring in those customers. For example, Dollar Tree accepts food stamps as a method of payment for their merchandise and soon enough so will Family Dollar.

Volume per Customer The amount of goods purchased by a customer brings more profit and sales to the dollar stores. With the average customer of Family Dollar and Dollar General spending, “just $8 and $11 per shopping trip, respectively” (Discount Store News Dec. 8, 1986), it’s painfully apparent why the volume per customer is essential to these discount stores. With these customers buying approximately eight items, since most items are priced around one dollar, the more customers that these general merchandise stores can attract the better for the company.

Conclusion Through all of the points discussed above, it is obvious for one to see that the bargaining power of customers for the variety discount stores is moderate. The customers have some say as to what the stores in the discount variety industry offers.

Bargaining Power of Suppliers

The last part of the Five Forces Model is the bargaining power of suppliers. There are “twenty five competitors for Family Dollar Stores” (Hoovers.com). These discount stores carry many different types of merchandise ranging from TracFone prepaid cell phones to Tampax tampons to Texaco anti freeze coolant, which are all offered at Family Dollar Stores. Therefore, it is easy to understand that there needs to be a respectable relationship between the company and its suppliers. Vikas Wai, Family Dollar’s director of e-commerce, supports this by saying, “We need a strong relationship with our suppliers to ensure that we can manage our inventory to keep the prices low and the right products in stock”. Many of the full-line discounters have private brands and national product brands stocked on their shelves.

Therefore, retail stores main objective is to keep costs and prices as low as possible. The relationship that Family Dollar has with its suppliers seems to be very good. “The company purchases merchandise from approximately 1,400 suppliers and generally has not experienced difficulty in obtaining adequate quantities of merchandise” (Family Dollar 10K). The company is able to have plenty of product depth and a large volume of them to offer to their consumer. The company wants those name brands for cheap in their stores to attract lower income customers. Suppliers often have items that become discontinued. The “dollar” stores come in handy and also profit by taking these discontinued items off suppliers’ hands. The discount variety stores will always take cheap merchandise. There are also many different suppliers to choose from in the industry. If one supplier will not meet the need of the mass merchandise store by means of volume or price of a product, the company will simply find other means of filling that specific product and need. For instance, when Proctor and Gamble refused to make a deal on Pampers for the President of Family Dollar Howard Levine, he simply stocked more of the Kleenex brand of disposable diapers and Family Dollar’s own brand of diapers. Soon enough, the need of Pampers by consumers was obsolete (Answers.com). Levine had to come up with a new idea since the deal with Proctor and Gamble failed, but still meet his customers’ value and price expectations.

Conclusion Since many of the discount stores deal with many suppliers, the bargaining power of suppliers is low. If one supply will not offer the right price for a product, the general merchandiser can easily find a supplier who will.

Value Chain Analysis

There are two strategies for creating a competitive advantage for any firm: differentiation, and cost leadership. Differentiation seeks to ascertain a novel and innovative product or service that is difficult to duplicate well or possesses some first mover advantage. Cost leadership, on the other hand, focuses on cutting input costs to increase profit margin. In general the Discount, Variety Store industry adopts the latter. However, such a broad industry encompasses a variety of firms from the humble 99 Cents Only Inc. (NDN) to the massive Wal-Mart Stores Inc. (WMT). To get a better understanding of who competes most directly with Family Dollar Inc. (FDO) the industry must be broken down further. FDO and to other “dollar” chains operate in the, “general merchandise and retail store” (FDO 10-K 2007), segment that provides, “primarily low to lower-middle income consumers a wide range of competitively priced basic merchandise in convenient neighborhood stores.” (FDO 10-K 2007). Once broken down it is obvious that the “dollar” stores do not compete on the same level as the super centers. It is also much clearer that in a sub industry which thrives almost entirely on thrift, why a strong cost leadership strategy that emphasizes economies of scale, reduced input costs, low-cost distribution, and a tight cost control system, is a staple for long-term success.

Economies of Scale In any large retail business economies of scale play some role as part of a cost leadership strategy. In the discount variety industry companies live and die by economies of scale. Economies of scale arise and become increasingly apparent as a company grows. In the retail industry the bigger the order the lower, “the average cost per unit since fixed costs are shared over an increased number of goods” (investopedia.com). Not this entire concept is based on production and order capacity, however. Much is politics in the form of relationships with the suppliers as discussed in the prior sections. A firm that makes efficient use of its economies of scale will, in principle, be able, “to earn above-average profitability by merely charging the same price as its rivals.”

(Palepu, 2-9) and when most of your products retail in a, “range from under one dollar to ten dollars” (FDO 10-K 2007), any weakness in this area becomes painfully apparent on the bottom line.

Reduced Input Costs In the Discount, Variety Store industry the inputs in the value chain are not the same as in the manufacturing industry. Instead of raw material and manufacturing processes the inputs that make up the variety store industry focus on property purchasing and renovations, frugal advertising, and wages. The majority of the firms in the discount retail segment lease their store locations as opposed to buying them out right. This allows leases that are, “relatively low-cost, short-term leases (usually with initial or primary terms of three to five years) often with multiple renewal options.” (Dollar General 10-K 2007). In the unlikely event that a new store is built or bought, it is treated as a valuable investment and all parameters of the construction or sale are vehemently researched prior to completion. In an effort to keep profit margins elevated in accordance to a cost leadership strategy, all of the “dollar” store chains are misers when it comes to the advertising budget. At Dollar General, for instance, “Advertising expenses remained less than 1% of sales.” (Dollar General 10-K 2007), for the 2007 fiscal year. The other players of the discount retail segment keep their advertising budgets at comparable levels. To keep these budgets in check most “dollar” stores abandon television and radio spots in favor of much cheaper and more local paper circulars that contain various coupons and promotions. Limited radio advertising is utilized only for new store openings in metropolitan areas, and during the holiday season. As with most any industry, the most expensive of all the operating expenses are the employees. From wages to fringe benefits they represent one of the largest strains on a firm’s gross income. The discount variety industry manages these in two important ways. Firstly and most obviously, they staff

their stores and distribution centers with the absolute minimum number of employees to keep them operating efficiently, without fracturing any state and/or federal labor standards legislation. Seasonal help is also used to maintain operational efficiency during peak sales periods throughout the year without putting a strain on company resources during non-peak periods. The second facet in keeping wage expense low is to maintain a positive relationship with employees to prevent unionization. Currently among the nationwide “dollar” store chains, “None of the employees are subject to collective bargaining agreements.” (Dollar Tree 10-K 2007), thus saving the companies the substantial costs of abiding by such agreements.

Low-Cost Distribution In an industry that depends on the availability of goods to sell while maintaining a cost leadership strategy, cost-effective product distribution is of the utmost importance. The present industry norm for nation-wide companies are to employ both company owned trucks and privately contracted carriers in tandem to replenish stores. These trucks are deployed from strategically placed warehouses that are, “designed to improve inventory flow to consumers” (Dollar General 10-K 2007). This method has proved itself in many industries prior to the discount retail segment and has only just recently been deployed in the “dollar” store business with great success. The deployment of a supply chain with this level of efficiency is essential to satisfy the recent growth of the discount variety industry, “dollar” stores in particular.

Cost Control: A Conclusion All of the afore mentioned points are integral parts of a tight cost control system. The absence and/or deficiency in any one of these parts will place a company, within the discount variety industry, at a disadvantage compared with a company that successfully implements a said strategy. Because of this industry’s emphasis on cost control as a means of survival, a firm that ignores

this theory will soon find itself downsizing, bankrupt, or under new ownership. This leaves the remaining firms that can survive in such a competitive environment, continually seeking ways to grow profit margins. In this highly concentrated industry segment, stealing market share is becoming increasingly difficult. As a result, cost control strategies present the most viable option for companies within the industry to grow profits.

Firm Competitive Advantage Analysis

The discount, variety store industry, “in which the Company [Family Dollar Inc.] is engaged is highly competitive.” (FDO 10-K 2007) and highly concentrated. Being such, FDO has adapted their own version of the cost leadership strategy in order to maintain a competitive advantage. FDO sees their main competitive factors as, “store locations, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service.” (FDO 10-K 2007). As such, their cost leadership strategy concentrates on: economies of scale, reduced input costs, low-cost distribution, and a tight cost control system.

Economies of Scale Economies of scale play an important role in any retail chain whether it be a hardware store or a specialty retailer, like an auto parts store. Family Dollar Inc. knows the importance of economies of scale and as such has a considerable supply chain that, “purchases merchandise from approximately 1,400 suppliers” (FDO 10-K 2007). This large network of suppliers not only keeps the price and quality of merchandise above industry standards, but adds a degree of depth to FDO’s product lines. FDO also has the fact that it is one of the leaders of the “dollar” store industry, in terms of market cap and quantity of store locations, working in its favor. FDO has a significantly increased buying power and the

bigger the order the lower, “the average cost per unit since fixed costs are shared over an increased number of goods” (investopedia.com). FDO also limits the influence of their suppliers by allowing, “No single supplier to account for more than 9% of the merchandise sold” (FDO 10-K 2007), by FDO in a single year. This check on the power of suppliers and their sheer size, helps FDO keep the economies of scale in their favor.

Reduced Input Costs As Family Dollar Inc. is a retailer, they do not have the typical inputs of a manufacturing company. Instead of raw materials FDO has less conventional inputs that comprise their value chain. The inputs that make up the variety store industry focus on property purchasing and renovations, frugal advertising, and wages. FDO leases the majority of their store locations as opposed to buying them out right. This allows fewer long term maintenance and upkeep costs while affording the opportunity to easily switch to more lucrative markets at the culmination of the lease agreement. In addition, all, “stores are operated on a self-service basis” (FDO 10-K 2007), which means that customers enter the store and primarily help themselves with little intervention from the minimal sales staff. The goal herein is to keep overhead as low as possible with only a slight sacrifice to customer service. Family Dollar Inc. like most other companies in the same industry keeps advertising costs to a minimum. They are able to do this while still attracting new customers, solely by the considerable bargains they offer their lower income customer base. To supplement their word-of-mouth advertising, FDO also, “advertises through circulars available in stores or, occasionally, circulars that are inserted in newspapers” (FDO 10-K 2007). In the recent past FDO has also introduced a “Treasure Hunt” merchandising campaign that involves further reduced prices on select products that are “hidden” throughout the store; all this to induce excitement among shoppers and increase repeat customers.

Family Dollar Inc. is a relatively large company that requires a large labor force, specifically, “approximately 24,000 full-time employees and approximately 20,000 part-time employees” (FDO 10-K 2007), to operate smoothly. This substantial labor force must be maintained while trying to keep overhead at the lowest possible level. To accomplish this, FDO has divided their 44,000 person labor force up over, “6,200 general merchandise stores” (FDO 10-K 2007), and nine distribution centers which computes to an average of slightly over seven employees per establishment. Take into consideration that the average size of one of their general merchandise stores is, “approximately 7,500 to 9,500 square feet” (FDO 10-K 2007), not including distribution centers, and it becomes evident how important it is to keep payroll to a minimum.

Low-Cost Distribution In the discount, variety store industry, product logistics like any other input, must be run efficiently, to maintain a cost leadership strategy. To do this Family Dollar Inc. has roughly 6.5% of its merchandise, “shipped directly to its stores by the manufacturer or importer.” (FDO 10-K 2007), saving FDO the costs associated with having the same products shipped using their resources. The remaining proportion of merchandise is shipped via company-owned trucks or contracted common carriers. Before that merchandise is shipped by company and common carrier trucks, it travels to one of nine distribution centers which are strategically placed around the United States to minimize distance between the warehouse and the stores served.

Number and Average Distance of Stores Served by Each DC

Distribution Center Number of Stores Served Avg. Distance (Miles) Matthews, NC 708 159 West Memphis, AR 679 264 Front Royal, VA 756 200 Duncan, OK 779 314 Morehead, KY 701 201 Maquoketa, IA 781 294 Odessa, TX 662 566 Marianna, FL 628 267 Rome, NY 479 222 Total 6,173 276 (FDO 10-K 2007)

In addition to their optimal locations, the distribution centers utilize, “high- speed sortation systems” (FDO 10-K 2007), and computer based perpetual inventories at every store, to keep in-stock consistency and merchandise assortment at unparalleled levels. All of these items working in unison keep the distribution cost per unit among the lowest in the industry.

A Tight Cost Control System All of the afore mentioned elements, from the economies of scale to the low-cost distribution are essential rudiments of Family Dollar Inc.’s cost control system. However, like any competitive firm, FDO supplements these foremost elements with other, more subtle, cost-cutting techniques. Chiefly, the relatively small size of the typical FDO store allows FDO to utilize older, more economic strip-mall locations rather than incurring the property and building expense for

the construction of stand-alone stores. The utilization of strip-mall locations also affords FDO the option to take over existing business chains that also frequent this type of real estate at a significant cost savings versus purchasing the same locations individually. Finally, FDO’s, “Vendors’ trade payment terms are negotiated to help finance the cost of carrying” (FDO 10-K 2007), added inventory; in other words FDO gets an even deeper discount to take delivery of larger-than-needed quantities or slow selling merchandise.

On The Horizon There is no question that in being a low-cost retailer Family Dollar Inc. has adopted a cost leadership strategy instead of one based on differentiation. This, however, does not mean that FDO hasn’t integrated clever differentiation techniques to keep competitors one step behind. As part of their, “multi-year “store of the future” initiative, the Company is installing new point-of-sale systems that will allow it to accept a broader range of tender types, including food stamps” (FDO 10-K 2007), and non PIN-based credit cards, which the Company currently does not accept. These added offerings, especially the ability to accept food stamps, will no doubt increase customer traffic given the low- income clientele that FDO caters to. FDO also plans, “to install coolers in approximately 1,200 additional stores.” (FDO 10-K 2007), to broaden product offering to include many common perishable grocery items. All of this is an effort to pull customers out of competing chains and thus, gain valuable market share in an otherwise saturated industry.

Accounting Analysis

The second step in a business valuation and analysis is an accounting analysis. In order to understand the intrinsic reality of the business, one must understand the degree to which a firm’s accounting reports reflect such. Firms have the opportunity to distort accounting numbers in order to make the business more appealing to investors. An accounting analysis will “evaluate accounting quality by assessing accounting policies and estimates” (Palepu Healy 2008). Executing an accounting analysis involves a series of steps. The first step is to identify the key accounting policies that a firm chooses to represent the risks and success components of the business. Step two involves assessing the accounting flexibility. Managers’ degree of flexibility differs among firms depending on rules and regulations. Generally speaking, the more flexibility a manager is granted in choosing accounting policies, the more informative the accounting numbers are to an investor, pertaining to the economics of the firm. Step three in the analysis of accounting is to evaluate the accounting strategy the firm has chosen. Strategies will vary depending on the manager’s flexibility and whether or not the firm is trying to cover up actual performance or provide to the outside the economic standing of the firm. Evaluating the quality of disclosure is the next step in the accounting analysis process. There is a minimum disclosure requirement by law, so it is important to determine the quality of the disclosure by concluding if a firm reported beyond the minimum or not. The fifth and sixth steps are composed of identifying potential “red flags” and undoing the accounting distortions respectively (Palepu Healy 2008).

Key Accounting Policies

Family Dollar’s key success factors (KSF’s), as identified in the Firm Competitive Advantage Analysis, are economies of scale, reduced input costs, low-cost distribution, and a tight cost control system. These KSF’s are in line with FDO’s competitors as well, albeit they have their own methods for achieving a cost leadership strategy. All four of the KSF’s are geared toward reducing costs which is in line with FDO’s and the industry’s strict cost leadership strategy. This emphasis on cost leadership spawns the following Key Accounting Policies (KAP’s) for the “dollar” store industry: lease treatment, merchandise inventories, intangible assets (particularly goodwill), and employee retirement programs.

Lease Treatment The retail industry as a whole has a potentially huge liability related to their store locations. Every one of the large “dollar” store chains leases the majority of their store properties (FDO 2007 10-K, DLTR 2007 10-K, NDN 2007 10-K), even if most own their distribution centers. These leases can be treated in one of two ways, as operating leases or as capital leases. Operating leases treat lease payments as rent that is expensed when incurred. Family Dollar uses this method because it keeps these expenses of the balance sheet and recognizes these expenses much later. In addition, operating lease terms are generally shorter than capital lease terms. This allows FDO to more quickly vacate overpriced lease contracts for more cost effective leases which is in line with its emphasis on cost leadership. Capital leases are similar to mortgages from a financing perspective. They do affect the balance sheet and both short and long term liabilities. Unlike

FDO, Dollar Tree and 99¢ Only do show capital lease liabilities on their respective balance sheets. Dollar Tree’s capital lease obligation for 2007 was $400,000 compared with an operating lease obligation in the same year of $284 million (DLTR 10-K 2007). Ninety-nine Cent Only’s total capital lease obligation in 2007 was $699,000 compared with a total operating lease obligation of $196 million (NDN 10-K 2007). These figures show that the “dollar” store industry heavily favors the use of operating leases due to the fact that they keep significant liabilities of the balance sheet and their compatibility with the cost cutting KSF’s. Operating and capital lease will be discussed in detail in the “Potential Accounting Flexibility” section.

Merchandise Inventories Merchandise inventories represent the second KAP because they make up such a huge part of the total assets of retail stores.

Merchandise Inventory as a percentage of Total Assets 2007 2006 2005 DLTR (millions) $ $ $ Merchandise Inventory 605.00 576.60 615.50 $ $ $ Total Assets 1,873.30 1,798.40 1,792.70 Percentage 32% 32% 34%

NDN (thousands) $ $ $ Merchandise Inventory 152,793.00 139,901.00 147,609.00 $ $ $ Total Assets 643,135.00 628,708.00 629,611.00 Percentage 24% 22% 23%

FDO (thousands) $ $ $ Merchandise Inventory 1,065,898.00 1,037,859.00 1,090,791.00 $ $ $ Total Assets 2,624,156.00 2,523,029.00 2,409,501.00 Percentage 41% 41% 45%

Dollar General (thousands) $ $ $ Merchandise Inventory 1,432,336.00 1,474,414.00 1,376,537.00 $ $ $ Total Assets 3,040,514.00 2,980,275.00 2,841,004.00 Percentage 47% 49% 48%

Consistency in these figures is more important that growth, as growth can represent inefficiency in the Day Supply of Inventory and Inventory Turnover metrics. Also, any unnecessary growth in inventory is an increase is an expense as it costs money to carry additional inventory. A slight decline in the percentage figures is positive in the discount store inventory and runs parallel to a tight cost control KSF.

Goodwill Goodwill is the third KAP because Family Dollar and its direct competitors chain stores and always looking for cheap expansion. The easiest way for them to expand is to purchase slower growing chains, or acquire, “store leases through bankruptcy proceedings” (DLTR 10-K 2007). These purchases allow for goodwill to find its way on to the balance sheet as an asset. Neither Family Dollar nor 99¢ Only record any goodwill, even in their “other asset” sections of the balance sheet, according to their respective 10-K’s. Both Dollar Tree and Dollar General do, however, record goodwill as an asset on the balance sheet. While Dollar Tree’s disclosure is very good, with a separate line item displayed for goodwill, Dollar General lumps their goodwill in with the “other assets” section of their balance sheet. Investors must beware of any goodwill as it is aggressive accounting because it inflates assets but usually does not provide any revenue for the company.

Retirement Programs

The final KAP for the “dollar” store inventory is employee retirement programs. FDO and its competitors are required to have a “voluntary compensation federal plan, under section 401(k) of the Internal Revenue Code” (FDO 10-K 2007). Even with a strictly voluntary program, the company’s required investment in such plan can be substantial given the large number of workers employed by retail chains. All retirement contributions by their respective firms were available in the 10-K’s for at least three years; however, even when Dollar Tree, which paid the most contributions, with $16.8 million being paid out in 2007, this number was only 0.423% of their $3.9 billion in net sales for 2007. Judging from this figure it becomes clear that the “dollar” stores’ goal of low cost keeps these retirement contributions to a minimum. The three other companies analyzed were significantly below 0.423% as a percentage of net sales. While, retirement programs could potentially represent a significant cost to the “dollar” stores, their relatively small size and good discloser keep their affect low.

Conclusion The firms of the discount retail industry measures success by their ability to implement a strong cost leadership strategy. The Key Accounting Policies for Family Dollar and its competitors are based off the Key Success Factors of a cost leadership strategy. Careful attention must be paid to the KAP’s, especially leasing and merchandise inventories, when evaluating the quality of financial statements. Fortunately disclosure is relatively good for all the KAP’s excluding the leasing and goodwill sections for some companies.

Potential Accounting Flexibility

In the early 21st century the failure of several fortune 500 companies, due to exceedingly “flexible” accounting practices, caused a wave of federal legislation. This new legislation gave the Securities and Exchange Commission (SEC) more power to police fraudulent and unethical accounting. In accordance with new laws, like the Sarbanes-Oxley Act of 2002, all companies were required to report with a higher degree of disclosure than before. Despite this new legislation; however, Family Dollar, like the rest of the major players in the discount, variety segment, still has the potential to add biased and/or speculative data to its financial statements. This additional information can either serve to add value and practical substance to the accounting statements, or serve as a shroud to keep outsiders ignorant of the company’s true financial condition. The areas that most often are subject for flexible accounting in the discount, retail segment are: lease treatment, merchandise inventories, intangible assets (primarily goodwill), and retirement programs.

Leases Most of the potential for accounting flexibility in firms that operate large retail chains comes from a few particular items. In companies that have such a large proportion of operating income tied up in store locations and property, lease treatment becomes the most significant of these items. Generally Accepted Accounting Principles (GAAP) requires that these leases be reported in one of two ways: as operating leases or as capital leases. Family Dollar’s use of leases will be discussed in detail later.

Operating Leases The operating lease is generally utilized for short term leases (5 years or less) and as there is no transfer of ownership the rent is expensed when incurred as a necessary cost of doing business. The lessee pays for the right to use the lessor’s property as a place of business. Because the rent in this type of lease is expensed it never shows on the balance sheet and only impacts the income

statement. This treatment of the leases has the potential to significantly understate liabilities and inflate retained earnings.

Capital Leases Capital leases, in contrast, are typically used for long term leases (10 years or more) and treat the asset as if it were being purchased by the firm. A long-term asset is placed on the balance sheet with a corresponding entry being made to long-term liabilities. Although not used by Family Dollar Inc. for any of their retail stores because expenses are recognized so much earlier, capital leases do offer some unique benefits. They afford to company the right to, “claim depreciation each year on the asset and also deduct the interest expense component of the lease payment each year.” (pages.stern.nyu.edu). They also can boost the CFFO of a firm that opts for a capital lease over an operating lease because the capital lease payments are divided between operating and financing activities, while operating lease payments show as cash outflows from operations, (Investopedia.com).

Merchandise Inventories The second major area for potential accounting flexibility in the discount, retail industry arises in the merchandise inventories item of the balance sheet. Not surprisingly the merchandise inventories makes up a significant, if not dominant, proportion of current assets on the balance sheets of chains that make all their money selling merchandise. In 2006, Family Dollar’s merchandise inventory accounted for 41% of total assets (FDO 10-K 2007). There is so much room for flexibility in this component because not this entire inventory remains sellable all of the time. Food perishes, trends subside, technology causes obsolescence, and things break. How and whether or not a firm impairs or writes down these assets after such occurrences determines the transparency and usability of its financial statements. The “dollar” stores have the luxury of not having to dwell on advancing technology and trendiness as the goods they

sell are neither high-tech, nor high fashion. They also have the unique advantage of purchasing other companies unwanted merchandise at deep discounts making a positive margin very easy to attain. The “dollar” stores do, however, have to worry about perishables and damaged goods. Perishables are becoming an increasing concern of the “dollar” store, especially with the advent of refrigerated coolers which has greatly expanded to amount of amount of these goods that the stores keep in inventory.

Goodwill The frequent acquisitions of smaller or struggling retail stores and chains that compete in the same segment as the nationwide retailers affords many opportunities for goodwill to be recorded. This represents the third area of potential flexibility. Family Dollar, unlike its competitors, does not recognize any goodwill. When goodwill is recognized it is treated as an intangible asset on the balance sheet and according to FAS 142, 2001 this asset need not be amortized, but simply tested annually by the company for impairment (Investopedia.com). This allows goodwill to be kept on the books till the respective company decides otherwise; this presents a potential problem because there is no real way to subjectively and objectively measure the market value of this goodwill. As a result, it can serve as a booster seat that falsely inflates firms’ assets, retained earnings, and earnings per share making it look much more attractive to potential investors.

Retirement Plans Pensions or compensation deferral plans represent the final area that is most often subject to flexible accounting by firms in the discount retail business. While these plans are offered to employees on a strictly voluntary basis, potential problems arise when companies use too large a discount rate to calculate the present value of future obligations. This estimation error in the discount rate will understate the present value of the future obligation the company has to its

employees in a defined benefit plan. Future expenses associated with these pension plans will far out pace the growth of funds that the company has invested to match against these expenses leading to a shortfall between revenues and expenses in the future.

Actual Accounting Strategy

Overview The analysis of a company’s actual accounting strategy involves both determining the transparency of its financial statements as high or low disclosure, and evaluating how aggressively or conservatively it utilizes its accounting flexibilities in the Key Accounting Policies. A high disclosure company’s financial statements will contain a wealth of data that divulges the true financial disposition of the company, both good and bad, to the public regardless of any effects on stock price. High disclosure financial statements will contain an unconsolidated balance sheet, income statement, statement of retained earnings, and statement of cash flows accompanied by detailed notes to the financial statements. Conversely, low disclosure financial statements report limited information using consolidated accounting statements, which can potentially mask the financial shortfalls of the company. They often bury the pertinent information deep within a complicated set of notes to the financials leaving much to be desired by investors. A company that uses its accounting flexibilities in an aggressive manner will boost assets, while minimizing liabilities and expenses in order to pad the financials and ultimately improve net income. A company practicing conservative use of its accounting flexibilities will

depreciate assets, and perform write-downs, regardless of the effects on net income. It is important to note that neither are the correct way and that extreme use of either aggressiveness or conservatism will degrade the quality of the financial statements.

Level of Diclosure Family Dollar Inc. (FDO) reports with a high degree of disclosure, which is in line with the rest of the companies in the industry segment. Their financial statements are complete and readily accessible to the public. Although FDO displays consolidated accounting statements in their 10-Ks, they are always accompanied by a comprehensive set of notes. It is important to note that no major discrepancies were found in almost any of the danger zones for accounting flexibility. FDO does not record any goodwill or any other intangible assets for that matter. Also, sales growth and inventory levels have grown together which suggests that FDO keeps its inventory assets at acceptable levels to meet a genuine growth in customer base; not just growth in inventory which could be a harbinger of substantial inventory write-downs in future periods. FDO’s does have a voluntary employee retirement plan; however, the company’s contribution expense related to this plan was less than 2% of net income for the last three fiscal years and properly disclosed in the financial notes (FDO 10-K 2007). FDO’s lease reporting is the last of the disclosure areas and, coincidently, the only area that FDO seems limit their disclosure. They appear to finance most of their store expansion and property acquisition using a leaseback method. This information is displayed in the notes to the financial statements, but significant computation is required to compute the magnitude of potential liabilities that are kept off the books by using this method. A complete estimation of these latent liabilities is performed later in the “Undo Accounting Distortions” section of this report.

Conservative/Aggressive Accounting

As could be derived from its relatively good disclosure in financial statements, Family Dollar Inc. takes a more conservative disposition on much of its Key Accounting Policies. As prior stated FDO’s inventory and asset growth has stayed in line with sales growth and even decreased compared with sales growth in fiscal 2005 to 2006.

Comparison 2002-2003 2003-2004 2004-2005 2005-2006 Company Average Family Dollar % Sales Growth 14.11% 11.19% 10.28% 9.79% 11.34% % Asset Change 13.17% 12.02% 8.32% 4.71% 9.56%

This can be interpreted as streamlining inventory forecasting and replenishment systems. While a decrease in overall asset could be seen as negative, when the decrease is primarily in merchandise inventory this leads to an increase in inventory turnover which is generally positive and on the conservative side. FDO does not have any goodwill recorded on the books but they have acquired other smaller chain and thus, have had the opportunity to recognize goodwill. The fact that they do not recognize this is a sign of conservatism because it does not drive up assets. Pensions are recorded in the notes but to not represent a significant expense for FDO. Lease treatment is the only KAP that FDO reports aggressively. The lease obligations for the leaseback financing if capitalized would nearly quadruple their long term liabilities of $329 million. A figure of this magnitude would change the entire outlook of the financials, not to mention many of the diagnostic ratios, current ratio and quick asset ratios in particular. The only redeeming factor is that leasebacking of this extent is the norm for the main competitors of FDO and becoming a norm for

any high-growth industry with substantial amounts of PPE.

Conclusion Family Dollar Inc.’s transparency and disclosure are generally very good. Conservatism is practiced for most of the Key Accounting Policies and throughout the financial statements. The only area where conservatism and disclosure are lacking is that of lease treatment. This can and should conjure some apprehensiveness by investors, but is not abnormal for the industry.

Quality of Disclosure Qualitative Analysis

The Family Dollar overall has presented its financial statements with formidable disclosure and transparency. Throughout the financial statements there are many notes thoroughly explaining key company policies and reasons for the information given. From 2002 to 2006 this has been consistent and not much has changed with the way the company chooses to disclose, and to the extent in which they choose to disclose key financial information. One example of open disclosure and transparency throughout the financial statements is where the company openly discusses and illustrates stock option compensation for management, based on performance. This benefit to the employees could prove to be a potential reason for noise in the way management reports its numbers. This would be considered to be decision useful information in the evaluation process. If incentives are given for a managers’ performance, they might be tempted to inflate profits or possibly modify the financial numbers in order to increase their bonuses. Given the companies’ openness regarding management compensation and stock options down to exact numbers, it makes it easier for an investor to derive their own opinion about the potential problems associated with the issue.

Another example of good quality of disclosure is the companies’ open discussion of all litigation in detail. In 2006, litigation the company was involved in was discussed many times throughout the financial report. The effect of the litigation was openly disclosed at 45 billion dollars. This disclosure is a very important component for a valuation. The Family Dollar has been in one particular law suit since 2001. Information concerning the progress of the suit has been openly discussed throughout the years. With ongoing litigation, it is important to know if there are going to be any further expenses in time and money of the company to rid of the charges, and if so , does the company have the resources to take care of the problem. The Family Dollar also discusses current operating leases in detail. Most of the stores are leased and very few are owned by the company. A large part of the stores that are leased “provide for contingent rental payments based upon percentage of store sales.” (Family Dollar 10k) This usually means that the more profitable the individual store is, the more the rent will be, and the less profitable the store is the less the rent will be. Even if the rent is lowered due to low sales of the store, there is almost always a base rent fee. This could be considered to be one part of the financial statements that is “cloudy” so to speak. The Family Dollar doesn’t break down each individual stores’ rent expenses on the companies’ income statements, rent expenses are reported as a lump sum. Having fluctuating lease payments might create flexibility in the company’s choices in reporting expenses to their advantage.

Conclusion Overall, The Family Dollar has disclosed most of its financial data with decent transparency and detail. Every step of the financial statements are openly discussed and are in an easy to follow format, making it less difficult to browse through the information. The fact that the reasoning behind the companies’ choice of reporting something can be found directly under the statements, makes it easier for investors to diagnose the numbers given in the financial

statements. The Family Dollar is much more open with their information than their competitors tend to be, which in turn might make an investor more comfortable investing in the company, if everything else was held equal.

Quantitative Analysis

The following analysis will look at core revenue diagnostics and core expense diagnostics. These ratios play an important role analyzing a company’s quality of disclosure because they can provide indirect evidence of any accounting distortions there may be. If there is a gross inconsistency when company is placed side-by-side with competitors, further research is wise.

Revenue diagnostics Possible Revenue diagnostics include net sales/cash from sales, net sales/net accounts receivable, net sales/unearned revenue, net sales/warranty liabilities, and net sales/inventory. The only diagnostic valid in our analysis is net sales/inventory. All other denominators mentioned previously are not reported or do not exist in this industry.

Net Sales ratio (net sales/inventory) This ratio shows how net sales are supported by inventory. In this industry, inventory control is usually not a priority. Firms in this industry do not have a large value of inventory on hand at any time. A spike in this ratio may not

even represent a manipulation. This ratio is not very helpful in the quantitative analysis.

The graph shows no spikes and therefore no reason to suspect tampering. Each company has a relatively steady ratio of net sales to inventory.

Conclusion The only core revenue diagnostic that is valid here is the net sales ratio. However unimportant this ratio is, it is the only revenue diagnostic we were able to compute. Sales divided by cash collection would have been an ideal ratio to compute and compare because it is a very common indirect indicator of revenue manipulation. Unfortunately, Family Dollar and other firms in this industry do not disclose line items: cash from sales, net accounts receivable, unearned revenue, or warranty liabilities.

Expense diagnostic ratios

Expense diagnostics help determine the believability of reported expenses as they appear on various financial statements found in every 10-K. Possible expense diagnostics include: asset turnover, raw and change form of CFFO/NOA, raw and change form of CFFO/OI, total accruals/change in sales, pension expense/SG&A, other employment expenses/SG&A. Total accruals cannot be computed with the given information. Also, no companies in this industry disclose pension expenses or other employment expenses.

Asset Turnover: (Net Sales / Total Assets) The asset turnover ratio is computed by divided net sales by total assets. This ratio shows how assets support net sales. A higher asset turnover ratio is favorable. Most companies in this industry use operating leases to run their stores rather than capital leases. This can be deceiving because a capital lease would show up on a balance sheet as an asset. Operating leases allow a company to report a rent expense on the income statement. Family Dollar is no different and uses operating leases for the majority of their stores. The capitalizing of operating leases will be shown and explained in the accounting distortions section. Family Dollar’s corrected Asset Turnover using capital leases is displayed in the graph. There was an increase in Total Assets, which led to a lower ratio. This is a classic example of “off balance-sheet financing” to favorably display financial indicators.

Cash Flow From Operations / Net Operating Assets: Cash flows from operations, found on the cash flows statements, divided by net operating assets, found on the balance sheet, shows how well a company utilizes its property, plant, and equipment. The graphs show that Dollar Tree has the highest ratio that steadily increases. Family Dollar’s ratio decreases slightly in 2003 and 2005, but stays relatively the same. The higher the ratio, the better a firm utilizes its PP&E to generate cash. Dollar Tree seems to perform the best. There is no revision needed for this diagnostic as CFFO and NOA were not affected by our capital lease corrections.

Cash Flow from Operations / Operating Income: Cash flow from operations divided by operating income, also known as EBIT (earnings before interest and taxes) is used to measure a firm’s profitability. This diagnostic can be very useful in the core expense manipulation process. This diagnostic will show whether or not cash flows from operations are

being reported accurately to operating income. Family Dollar had the highest ratio until 2005 when Dollar General took the lead. 99 Cents Only Store did not disclose enough accurate information to compute a ratio. There is no reason for suspiction in this ratio.

Conclusion When we first computed Asset Turnover, Family Dollar had the highest ratio by far. Upon further research, it was found that Family Dollar had used operating leases that allowed for huge amounts of liabilities to not be recognized. This was the only ratio that aroused a concern.

Potential “Red Flags”

After viewing Family Dollar’s 10K’s, the only true potential red flag found on the financial statements is the recording of operating leases. When companies use and record operating leases, they are usually only occupying the location for three to five years. When using an operating lease, financial statements only show it as an expense depreciated on a straight-line basis. After the time allocated, the company can choose to renew their lease with the lessor. So, the company could end up using the building for all of its useful life after all. This should then be recorded as a capital lease, but isn’t with Family Dollar, which is a red flag for the company.

Undo Accounting Distortions

As is the norm in this Industry, Family Dollar has many accounting tricks to keep liabilities off the balance sheet and maximize reported profits. This is commonly referred to as “off balance sheet financing.” The 10-K itself states that besides the corporate headquarters and distribution centers, almost all business done by Family Dollar occurs in buildings under operating leases. This grossly distorts the valuation of Family Dollar and requires a correction that will

significantly alter the financial statement. Any operating leases that are considered long-term need to be capitalized as Capital Assets. In simple terms, lease (rent) payments categorized under operating expenses will be adjusted and categorized as financing expenses. This is the proper treatment of long-term leases because such large liabilities and assets must be reported to truly reflect a firm’s financial position. The process of capitalizing operating leases will be explained with the aid of the following tables. After this adjustment, a domino effect will change financial statements, financial ratios and other important indicators of value and profitability. Family Dollar owns less than 500 stores while the other 6,000 are operated under lease agreements. According to the 10-K, the majority of these leases have initial terms of five to ten years with an option to renew for another five years. In essence, Family Dollar is able to “rent” their business locations where almost all their sales and profits are created. To make the most accurate estimation of capitalizing operating leases, the present value of reported lease obligation payments must be calculated. This method is accurate because operating leases are contractual agreements to make rent payments each year for a specified number of years. This allows one to compute the present value of reported rent expenses or contractual commitments in a firm’s 10-K. The quick and easy method would be to use the total contractual obligations reported in a firm’s most recent 10-K and divide it by the estimated life of the leases which may or may not be reported. We used a more accurate approach by researching Family Dollar’s lease commitments in each year. This allowed for very accurate rent expenses because they were updated each year. Family Dollar only reports five years of obligations and an item line labeled “thereafter” This makes it difficult to estimate how many more years to carry out the commitment since no specific amount of useful life years is disclosed. Using separate tables for each year allows us to observe a declining commitment and accurately estimate the remaining years. We used a discount rate of 5.33% because it is our observed long-term debt rate (FDO 10-K 2007)

2001 Capitalization of Operating Leases, Discount Rate 5.33% Year T Commitment PV Factor Present Value 2002 1 $141,579 0.949397133 $134,414.70 2003 2 $124,267 0.901354916 $112,008.67 2004 3 $100,980 0.855743773 $86,413.01 2005 4 $73,886 0.812440684 $60,027.99 2006 5 $43,864 0.771328856 $33,833.57 2007 6 $38,965 0.732297405 $28,533.60 2008 7 $38,965 0.695241056 $27,089.72 Total PV of Operating Lease Expenses: $482,321 2002 Capitalization of Operating Leases, Discount Rate 5.33% Year T Commitment PV Factor Present Value 2003 1 $169,240 0.949397133 $160,675.97 2004 2 $146,652 0.901354916 $132,185.50 2005 3 $118,929 0.855743773 $101,772.75 2006 4 $87,770 0.812440684 $71,307.92 2007 5 $54,982 0.771328856 $42,409.20 2008 6 $51,375 0.732297405 $37,621.41 2009 7 $51,375 0.695241056 $35,717.66 Total PV of Operating Lease Expenses: $581,690 2003 Capitalization of Operating Leases, Discount Rate 5.33% Year T Commitment PV Factor Present Value 2004 1 $190,840 0.949397133 $181,182.95 2005 2 $167,434 0.901354916 $150,917.46 2006 3 $136,444 0.855743773 $116,761.10 2007 4 $102,997 0.812440684 $83,678.95 2008 5 $67,204 0.771328856 $51,836.38 2009 6 $65,823 0.732297405 $48,202.01 2010 7 $65,823 0.695241056 $45,762.85 Total PV of Operating Lease Expenses: $678,342 2004 Capitalization of Operating Leases, Discount Rate 5.33%

Year T Commitment PV Factor Present Value 2005 1 $221,468 0.949397133 $210,261.08 2006 2 $196,109 0.901354916 $176,763.81 2007 3 $162,856 0.855743773 $139,363.01 2008 4 $125,851 0.812440684 $102,246.47 2009 5 $88,680 0.771328856 $68,401.44 2010 6 $86,286 0.732297405 $63,187.01 2011 7 $86,286 0.695241056 $59,989.57 Total PV of Operating Lease Expenses: $820,212.40

2005 Capitalization of Operating Leases, Discount Rate 5.33%

Year T Commitment PV Factor Present Value 2006 1 $252,588 0.949397133 $239,806.32 2007 2 $225,649 0.901354916 $203,389.84 2008 3 $188,636 0.855743773 $161,424.08 2009 4 $150,096 0.812440684 $121,944.10 2010 5 $107,522 0.771328856 $82,934.82 2011 6 $105,660 0.732297405 $77,374.18 2012 7 $105,660 0.695241056 $73,458.82 Total PV of Operating Lease Expenses: $960,332.16 2006 Capitalization of Operating Leases, Discount Rate 5.33%

Year T Commitment PV Factor Present Value 2007 1 $271,811 0.949397133 $258,056.58 2008 2 $241,454 0.901354916 $217,635.75 2009 3 $203,066 0.855743773 $173,772.46 2010 4 $159,912 0.812440684 $129,919.01 2011 5 $114,104 0.771328856 $88,011.71 2012 6 $110,617 0.732297405 $81,004.54 2013 7 $110,617 0.695241056 $76,905.48 Total PV of Operating Lease Expenses: $1,025,306

The effect on financial ratios and financial statements will be illustrated and explained later in the valuation.

Financial Analysis

The financial analysis is essential to forming an accurate and fair valuation of a firm’s stock price. The financial ratios are the most important tool in the financial analysis as they help chart a company’s performance over time on many different benchmarks. There are three types of valuation analysis ratios: liquidity, profitability, and capital structure that will be discussed in the following sections. The financial analysis also involves adjusting the financial statements for capital lease treatment to maintain a better understanding of the firm’s true

assets and liabilities. In particular, retail chains are notorious for keeping these substantial numbers off the balance sheet in the form of operating leases. Finally the financial analysis involves extracting the proper figures to be used in the actual valuation of the firm. The company’s cost of debt, cost of equity, cost of capital, risk free rate, etc. are all derived in this section so that CAPM and WACC models can be performed accurately.

Liquidity Ratios

Liquidity ratios are a great measure to help a company figure out if they are able to pay off their current short-term debt obligations. The higher this number is, the better for the company. There are five different ratios a company can use to determine this: Current ratio, Quick Asset ratio, Accounts Receivable Turnover, Days Sales Outstanding, Inventory Turnover, Days Supply of Inventory, Working Capital Turnover, and the Cash to Cash Cycle. These ratios are talked about more in-depth below. Current Ratio : (current assets/current liabilities)

A company’s current ratio is determined by its current assets divided by its current liabilities. This ratio shows whether the company is able to cover its short-term debt obligations. It is not good if this ratio is less than one. The higher the current ratio means the company is very liquid.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 2.07 1.99 1.94 1.61 1.51 1.44 Dollar Tree 2.80 3.47 2.73 3.29 3.19 2.50 Dollar General 1.37 1.99 2.20 2.10 2.14 2.09 99 Cent Only 7.74 6.38 4.81 2.84 3.13 N/A Industry Average 3.50 3.46 2.92 2.46 2.50 2.01

Over the past six years, Family Dollar’s current ratio is good. It has always been over one. For example, in 2006, Family Dollar’s current ratio equaled 1.44. This means that for every dollar of current liabilities, the company has $1.44 in current assets to cover its current liabilities. If the current ratio becomes less than one, the company does not have enough resources on hand to cover its short-term debt. A target current ratio would be anything above one. As long as this ratio is more than one, the company is in good shape since it has enough current assets to cover is current liabilities (debt). This is a concern for the banker (or loan broker) if a company’s current ratio is less than one. Then the company will not be able to pay off their current debt with the current assets available. No company’s listed above current ratio is less than

one. Family Dollar and its competitors are in good position. Family Dollar’s current ratio over time has gradually decreased. This could be caused by our merchandise inventories, or assets in general, being less or by the company taking on more liabilities.

Quick Asset Ratio: (cash + securities + accounts receivables)/(current liabilities)

The Quick Asset Ratio (also known as the Acid Test) is a good tool to determine a company’s financial strength. The formula for this ratio is cash plus securities plus accounts receivables all divided by current liabilities. This ratio goes deeper than the current ratio by involving all of the most liquid assets that can be converted into cash. The higher the number means the company has strong financial strength.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 0.06 0.41 0.35 0.26 0.16 0.22 Dollar Tree 1.18 1.41 0.64 0.36 0.22 0.22 Dollar General 0.23 0.18 0.46 0.28 0.25 0.23 99 Cent Only 0.13 0.28 0.04 0.04 0.08 0.07 Industry Average 0.40 0.57 0.37 0.24 0.18 0.19

Family Dollar has kept a pretty consistent Quick Asset ratio. But it has gotten smaller compared to 2002 when it was at its highest at 0.41. In 2006, Dollar General had the best ratio out of all of the dollar stores. Dollar Tree outperformed its competition in 2001 and 2002. Also, in 2002, the whole industry’s quick asset ratio rose. Just as the current ratio, companies want their quick asset ratio to be greater the one. If the quick asset ratio is one or greater, this means that they are able to pay off their current debt with its most and easily liquid assets. Inventory is not used in this ratio because some company’s inventory might be slow moving. Not including inventory helps the company find out a more real look at the company’s ability to meet its current obligations. So, in 2006, Family Dollar had $0.22 of Quick Assets to meet $1.00 of its current liabilities. This is a very low quick asset ratio and means that Family Dollar is not in a good position to meet its current debt.

Accounts Receivable Turnover: (sales/accounts receivable)

The Accounts Receivable Turnover is the company’s sales divided by its accounts receivables. This ratio determines how quickly the company collects its accounts receivables.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A N/A N/A N/A N/A N/A Dollar Tree N/A N/A N/A N/A N/A N/A Dollar General N/A N/A N/A N/A N/A N/A 99 Cent Only 69.30 71.04 75.88 95.99 N/A 17.47 Industry Average 69.30 71.04 75.88 95.99 N/A 17.47

Family Dollar has no accounts receivable, so there is no accounts receivable turnover for the company. It is not a relevant ratio needed in this analysis for Family Dollar. 99 Cent Only Stores is Family Dollar’s only competitor that has accounts receivable therefore it is the only one with an Accounts

Receivable Turnover. 99 Cent Only Store’s accounts receivable turnover in 2006 was 320.573. This means for every dollar of accounts receivable, the company has $320.57 in sales to cover its accounts receivables.

Day Sales Outstanding: (365/ Accounts Receivable Turnover)

The Days Sales Outstanding equals 365 (the number of days in a year) divided by the accounts receivable turnover. This ratio tells you how long it takes a company to collect revenue after a sale has been made. The lower this ratio is the better.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A N/A N/A N/A N/A N/A Dollar Tree N/A N/A N/A N/A N/A N/A Dollar General N/A N/A N/A N/A N/A N/A 99 Cent Only 164.14 259.33 384.17 280.73 N/A 320.57 Industry Average 164.14 259.33 384.17 280.73 N/A 320.57

Once again, Family Dollar does not have a Days Sales Outstanding ratio since the company has no accounts receivable on its books. 99 Cent Only Stores is the only competitor with this ratio. In 2001, it takes 99 Cent Only Stores 2.2 days to collect its accounts receivables from its customers. This ratio is also used in the Cash to Cash Cycle (or the Money-Go-Round) ratio.

Inventory Turnover: (cogs/inventory)

Inventory Turnover is determined by taking the company’s cost of goods sold divided by its inventory. This ratio tells us how many times a company’s inventory is sold and then replaced over a specific period of time.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 3.38 3.61 3.68 3.57 3.58 4.12 Dollar Tree 4.29 4.14 3.39 3.27 3.85 4.32 Dollar General 3.37 3.90 4.19 3.92 4.15 4.75 99 Cent Only 5.27 5.14 4.81 3.80 N/A N/A Industry Average 4.08 4.20 4.02 3.64 3.86 4.40

In 2006, Family Dollar’s inventory turnover was 4.12. This means it took 4.12 times for Family Dollar to sell its inventory and then replace it with new inventory. 99 Cent Only Stores had the worst inventory turnover by far in 2006. It took 20.89 times to replace its inventory once it was sold for this company. The industry pretty much kept steady in line with each other. If the inventory turnover is low, this could mean poor sales and an excess amount of inventory for the company. But if this ratio is high, it could be because of a lot of sales that the company is making. A high inventory turnover is a good implication of positive operating efficiency of the company, but this could not always be the case. This is why we need to look at Family Dollar’s competitors and get the industry average to compare to see if the inventory turnover ratio for Family Dollar is good or not. The past three years, Family Dollar’s inventory turnover has been close to the industry average.

Days Supply of Inventory: (365/Inventory Turnover)

Days Supply of Inventory is the inventory turnover divided into 365. Also known as Days Inventory Outstanding (DIO), this measure will give an investor a figure of the number of days it takes for a firm to convert inventories into sales. A lower (shorter) Days Supply of Inventory indicates a firm operating more efficiently as versus a higher DIO figure. DIO is added to day’s sales outstanding to compute a cash conversion cycle figure.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 107.97 101.14 99.13 102.32 101.86 88.58 Dollar Tree 85.119 88.135 107.7 111.57 94.726 84.536 Dollar General 108.25 93.67 87.01 93.08 87.97 76.86 99 Cent Only 69.30 71.04 75.88 95.99 Industry Average 92.66 88.50 92.43 100.74 94.85 83.33

Family Dollar’s Days Supply of Inventory stayed relatively the same from 2001 through 2006. Year 2006 was Family Dollar’s best DIO figure with 88.58 days for them to convert inventories into sales. In 2004, Dollar Tree had the worst Days Supply of Inventory which was 111.57 days. There was no information available for 99 Cent Only Stores in 2005 and 2006. This is why there is no DIO figure for these years. In the last year that 10K’s were available, in 2006, Dollar General by far had the best Days Inventory Outstanding out of the four companies. Dollar General had a 76.86 days supply of inventory. Family Dollar had the worst in the industry this year of 88.58 days, but this was there best figure out of the six years. Overall, the discount variety store industry kept about the same with each other over the past six years.

Working capital turnover: (Sales/Working Capital)

Sales divided by the difference of current assets minus current liabilities will yield the working capital turnover. “The working capital turnover ratio is used to analyze the relationship between the money used to fund operations and the sales generated from these operations” (investopedia.com). The higher the turnover the better because that means a firm is producing a high number of sells relative to a low amount of working capital (money).

Company 2001 2002 2003 2004 2005 2006 Family Dollar 8.79 7.93 8.46 10.79 12.66 14.78 Dollar Tree 5.51 4.57 6.12 4.63 5.24 6.89 Dollar General 12.60 9.25 7.61 8.46 9.28 10.08 99 Cent Only 2.98 3.46 3.96 5.26 Industry Average 7.47 6.30 6.54 7.28 9.06 10.58

Again, there was no available information for 99 Cent Only Stores in 2005 and 2006. Their worst working capital turnover was 2.98 in 2001. But it is slowly getting bigger which is good. Over the past six years, Family Dollar’s best Working Capital Turnover was in 2006 with a turnover of 14.78. This is the best turnover of all of the companies from 2001 to 2006. The industry’s average keeps getting better year after year.

Cash to Cash Cycle: (Days Sales Outstanding + Days Supply of Inventory)

The Cash to Cash Cycle, also referred to as the Money-Go-Round, is determined by taking the Days Sales Outstanding plus the Days Supply of Inventory. This formula measures how long it takes to receive accounts receivable and how long to convert inventory into sales. It is bad for the company when this number increases. “The higher the number, the longer a firm’s money is tied up in the business operations and unavailable for other activities such as investing” (Wikipedia.com). This is an important measure for any business.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 107.97 101.14 99.13 102.32 101.86 88.58 Dollar Tree 85.12 88.13 107.70 111.57 94.73 84.54 Dollar General 108.25 93.67 87.01 93.08 87.97 76.86 99 Cent Only 71.52 72.45 76.83 97.29 N/A 18.61 Industry Average 93.22 88.85 92.67 101.07 94.85 67.15

The only company in the four above that takes into account the days sales outstanding and the days supply of inventory is 99 Cent Only Stores. The other three companies, Dollar General, Dollar Tree, and Family Dollar, do not have a Days Sales Outstanding. So their Cash to Cash Cycle only takes into account the Days Supply of Inventory. Family Dollar’s Cash to Cash Cycle stayed relatively the same from 2001 to 2005. In 2006, the Cash to Cash Cycle for FDO went down to 88.58 days which is better than the previous years. Over the past six years, Dollar Tree had the worst Cash to Cash Cycle in 2004 with a cycle of 111.57 days. The industry average was the best in 2006 with an average Cash to Cash Cycle of 67.15 days.

Overall Liquidity Ratios Conclusion Again, the liquidity ratios help a company determine whether or not they can pay off their short-term debt obligations. The higher the ratio is gives the company a higher margin of safety. Family Dollar does not seem to be a fairly liquid company. Two of the most important ratio, Current Ratio and Quick Asset Ratio, illustrated Family Dollar’s poor performance. The firm was not even to beat the industry average in most years. It would make investors more confident and secure if Family Dollar was able to pay its current debts off more easily. Family Dollar did not perform well on the remaining liquidity ratios as well. Overall, our assessment of Family Dollar’s liquidity is that they are poorly to averagely liquid.

Profitability Ratios

Profitability ratios are used to assess a company’s ability to generate revenue taking into consideration their incurred costs of everyday operations. A higher ratio compared to another company is a usually a favorable measure. These ratios are the Gross Profit Margin, the Operating Profit Margin, the Net Profit Margin, the Asset Turnover, Return on Assets, and Return on Equity. These Profitability ratios are discussed more below.

Gross Profit Margin: (Gross Profit/Sales)

Gross profit is figured by subtracting the cost of goods sold from sales (revenue). The gross profit margin ratio is figured by dividing sales into gross profit. The higher the gross profit margin the more efficient a company is operating. Gross margin represents the amount of money left over for saving or paying other expenses after paying for the costs of sales. If a gross profit margin

is equal to 30%, a company will have $0.30 left over for every one dollar of sales. Gross profit margin is the most basic measure of product profitability.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 33.45% 33.53% 33.78% 33.81% 32.90% 33.13% Dollar Tree 36.03% 36.41% 36.37% 35.59% 34.54% 34.19% Dollar General 28.36% 28.26% 29.37% 29.54% 28.72% 25.83% 99 Cent Only 48.05% 40.14% 40.09% 39.05% N/A 37.46% Industry Average 36.47% 34.59% 34.90% 34.50% 32.05% 32.65%

Family Dollar’s gross profit margin stayed pretty stable over the last six years at around 33%. 99 Cent Only Stores had the best gross profit margin in 2001 with a margin of 48.05%. This was also the best out of all of the companies from 2001 to 2006. Again, there was no available information in 2005 for 99 Cent Only. The lowest gross profit margin out of the past six years was 25.83%, which was Dollar General. This means they are only earning $0.26

for every dollar of sales. Dollar General’s gross profit margin stayed in the 28% area. Overall, the industry average stayed around 34% over the past six years.

Operating Profit Margin: (Operating Income/Sales)

Operating profit margin is similar to Gross profit margin in the sense that it “is used to measure a company’s pricing strategy and operating efficiency” (investopedia.com). By dividing income from operations by sales, a percentage will be generated that will indicate the amount of every dollar of sales that is left over before interest and taxes. Again the higher the percentage the more efficient a firm is operating. Comparing the change in margin over past years of operations for a firm is a great way for analysts to determine the healthiness of a company.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 8.14% 8.21% 8.20% 7.70% 5.89% 4.87% Dollar Tree 10.00% 11.00% 10.00% 9.00% 8.00% 8.00% Dollar General 20.50% 28.40% 21.30% 21.80% 22.30% 22.20% 99 Cent Only 48.05% 40.14% 40.09% 39.05% 37.46% Industry Average 21.67% 21.94% 19.90% 19.39% 12.06% 18.13% Family Dollar (revised) 8.84% 8.95% 8.97% 8.46% 6.70% 5.82%

Family Dollar’s operating profit margin went from 8.14% in 2001 down to 4.87% in 2006. This margin is getting smaller for Family Dollar and it’s the smallest for the whole industry. 99 Cent Only Stores has the highest operating profit margin by far over the past six years. The highest was in 2001 with a margin of 48.05%. There was no available information for 99 Cent Only Stores in 2005. The industry average for these companies stayed around 20% give or take. The revised series was necessary because the capital lease adjustments increased operating income, resulting in a slightly higher margin.

Net Profit Margin: (Net Income/Sales)

Net Income divided by sales, which is the Net Profit Margin, is a ratio that will indicate the percent of a dollar of sales that a firm keeps as earnings. An increase in net income from year to year might look good but can be misleading if the actual percentage of net income to sales is decreasing. A decrease over the years signals a lowering level of operating efficiency. The net profit margin is an excellent ratio to use to compare firms in industries of similar nature.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 5.17% 5.21% 5.21% 4.88% 3.73% 3.05% Dollar Tree 6.00% 7.00% 6.00% 6.00% 5.00% 5.00% Dollar General 3.90% 9.25% 4.35% 4.49% 4.08% 1.50% 99 Cent Only 8.38% 8.51% 6.81% 2.86% N/A 1.12% Industry Average 5.86% 7.49% 5.59% 4.56% 4.27% 2.67%

There was an increase from 2003 to 2006 for Family Dollar’s Net Profit Margin. It went from 5.21% down to 3.05%. Dollar Tree’s margin stayed at around 6.0% over the years. The lowest net profit margin was for 99 Cent Only Stores in 2006. This margin was 1.12%. 99 Cent Only Stores also had the highest net profit margin out of these four companies with a margin of 8.51%. The industry average went from 7.49% in 2002 down to 2.67% in 2006. This industry doesn’t have a good level of operating efficiency in 2006 compared to 2002.

Asset Turnover: (Sales / Total Assets)

The asset turnover can be found by dividing total sales by total assets. This calculation measures the sales of the company in relation to the total assets a company has acquired. This illustrates the companies level of efficiency in using their assets to create sales. The higher this number is the better it is for the company and the more efficient and effective they are.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 2.62 2.37 2.39 2.37 2.42 2.53 Dollar Tree 2.20 2.09 1.89 1.74 1.89 2.12 Dollar General 1.99 2.09 2.62 2.16 2.70 2.88 99 Cent Only 1.64 1.62 1.56 1.62 1.63 Industry Average 2.11 2.04 2.11 1.97 2.33 2.29 Family Dollar (revised) 1.95 1.78 1.78 1.73 1.73 1.80

The Family Dollars asset turnover ratio was 2.53 in 2006. This means that for every dollar worth of assets the company is making 2.53 dollars in sales. In the past six years the number has dropped from 2.62 in 2001. At the lowest

point in six years the ratio dropped to 2.37 in 2002 and 2004. It has since started to increase slowly. The drop over time is not too significant but, is still important to point out. The increase in the last few years is a good sign that the company is making strides to improve. Even with the decrease, The Family Dollar is still ahead of all of its competitors except for The Dollar General, which boasted a 3.0 asset turnover in 2006 to top off a steady growth from 1.99 in 2001. Even with the decrease, the Family Dollar is still one of the top companies in respect of asset turnover, but the clear leader is The Dollar General. The Family Dollar revision resulted in a lower margin because total assets increased tremendously while sales stayed constant

Return on Assets: (Net Income/Total Assets)

The return on assets can be calculated by dividing the net income by the total assets of the company. The previous year’s assets are used in the calculation with the current year’s net income because the purpose is to measure the effect of the assets the company has invested in. the higher this number is the better. This tells investors that the company is using assets to make a profit.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 0.15 0.14 0.13 0.10 0.08 Dollar Tree 0.14 0.14 0.12 0.10 0.10 0.10 Dollar General 0.03 0.08 0.11 0.11 0.12 0.12 99 Cent Only 0.17 0.13 0.05 0.02 Industry Average 0.09 0.14 0.13 0.10 0.11 0.08 Family Dollar (revised) 0.10 0.09 0.09 0.08 0.06 0.05

The Family Dollar’s ROA has decreased steadily over the past six years from 15.5% in 2002 to 8.10% in 2006. This is a significant decrease and could raise eyebrows of investors. This shows that even though the sales have increased the net income has decreased when compared to assets. When compared to its competitors, The Family Dollar comes in third to the Dollar Tree which had an ROA of 8.10% in 2006 and Dollar General which boasted an 11.7% return. As an overall look all of the competitors’ ROAs took a fall from 05 to 06 so something obviously went on within the industry to cause this, so this can’t be considered to be an equally important year. In the conclusion, Family Dollar’s ROA has decreased and is cause for some concern. It has been in a steady declination since 2001, and it coming very close to not meeting the industry standards. FDO’s upper level management is not doing as good of a job as it competitors in producing income from the assets the firm has acquired. Similarly to Asset Turnover, the revised ROA is lower than the original because total assets increased and net income did not.

Return on Equity: (Net Income/ Equity)

The Return on Equity (ROE) can be calculated by dividing net income by equity. The return on equity is one of the most important ratios for an investor to look at because it measures how well the management is putting to use the money the investors have invested in the company. “Large publicly traded firms in the U.S. generate ROEs in the range of 11 to 13 percent.”(Business Analysis and Evaluation, Palepu & Healy.) Like the Return on Assets ratio, when computing the ratio it is important to note that the equity from the previous year should be used with the current year’s net income, as to see the effect of the investments in equity of from the year before.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 0.15 0.14 0.13 0.10 0.08 Dollar Tree 0.19 0.18 0.18 0.15 0.15 0.16 Dollar General 0.08 0.20 0.21 0.19 0.20 0.20 99 Cent Only 0.19 0.15 0.06 0.02 Industry Average 0.14 0.18 0.17 0.13 0.15 0.12 Family Dollar (revised) 0.15 0.14 0.13 0.10 0.08

The Family Dollar’s ROA decreased from 22.6% in 2002 to 13.66% in 2006 which is a significant difference. Except for Dollar General the rest of the competitors saw similar decreases. Even with the decrease, The Family Dollars Return on Equity is still above the U.S. average which is stated before to be 13%. This could mean that the high ratios in the earlier years could be abnormal when compared to the overall expected ratios for the industry brought forth by an unusual trend in this time period. The firms ROE percentage decreasing steadily is the main thing that is alarming but, most of the industry have experienced the same trend. The actual ROE for 2006 is just at the industry average, which according to the particular investor could be acceptable or not. In conclusion, the firm could do a better job implementing the capital raised through shareholder investing, to ensure the shareholders are satisfied and to create value for the firm. The Capital lease restructuring did not affect ROE.

Profitability Ratios Conclusion From all of the ratios listed above in this section, one can tell if a company is doing well or not. These profitability ratios are a great tool for companies to use to determine how much profit a company is earning after taking into account their expenses of operating. Looking at the ratios above, FDO has not been as successful as the other companies in regards to increasing ratio percentages. FDO had consecutive decreases across the board in all ratios except for Asset Turnover and Gross Profit Margin. When compared to the rest of the industry and FDO’s competitors, this is a poor performance. With this being said, even with the decreasing ratio percentages, FDO still beat the industry average in every profitability ratio except Operating Profit Margin. The Family Dollar, even though beating industry average, is performing poorly in context to profitability ratios when compared to its competitors. The firm could do a better job in investing in assets that will produce more income and use the shareholders’ investments to do the same. FDO could also improve on their operating efficiency and pricing strategy, to more closely resemble its competitor’s ratios. Overall, FDO is mediocre in comparison to its competitors and industry which should be made note of by investors.

Capital Structure Ratios

The following ratios and diagnostics help assess the degree to which a company is financed by debt and equity. One of the most important pieces of the information that can be pulled from these ratios is how much leverage, or the ratio of debt to total financing (Wikipedia.com), that the firm possesses. There are several ratios and growth rates that help ascertain a better understanding of a firm’s capital structure: debt to equity ratio, times interest earned, and the debt service margin.

Debt to Equity: (Total Liabilities/ Owners’ Equity)

The debt to equity can be found by dividing total liability by total equity. This ratio shows how much debt the firm is using to finance its assets. The lower the ratio the better it is because it means that the company is keeping debt low. While it is necessary for firms to borrow money to increase in profitability, it is important not to over stretch. A firm should try to aim for a ratio fewer than 2.0. This ratio is not only important to investors, but also banks. When money is borrowed from a bank, often times the bank will set the limits in which the debt to equity ratio cannot go above. If the ratio creeps above the specified limit, it could prompt penalization of the firm on the bank’s terms.

Company 2001 2002 2003 2004 2005 2006 Family Dollar 0.46 0.52 0.51 0.66 0.69 1.09 Dollar Tree 0.38 0.31 0.46 0.54 0.53 0.60 Dollar General 1.65 1.45 0.81 0.87 0.87 0.73 99 Cent Only 0.10 0.11 0.13 0.23 0.20 0.25 Industry Average 0.65 0.60 0.48 0.57 0.57 0.67

The Family Dollar has increased its debt to equity ratio from .46 in 2001 to 1.09 in 2006. This is a pretty big jump up, but is still under 2.0. This could be taken as a good thing because sales have increased over the last six years which could be a result of debt financing growth. Compared to its competitors the Family Dollar is borrowing about the same as the other companies even with a slightly higher ratio in 2006. This should be nothing for investors or banks to be worried about.

Times Interest Earned: (NIBIT/Interest Expense)

The times interest earned can be found by dividing the net income before interest and tax by interest expense. This ratio is vital in knowing if the firm can pay the interest charge from the borrowed money. The higher the ratio is the better. This indicates that the firm has enough to pay for its debt.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A N/A N/A N/A N/A 23.76 Dollar Tree 0.32 0.33 -38.54 -31.18 -19.60 -18.36 Dollar General 2.40 7.20 9.72 13.38 18.57 20.77 99 Cent Only N/A N/A N/A N/A N/A N/A Industry Average 1.36 3.76 -14.41 -8.90 -0.51 1.20

The Family Dollar did not have any data for the years leading up to 2006 but, did have a TIE ratio of 23.76 in 06. This is second to 99 Cent Store’s ratio of 25.36. Compared to the rest of the firms FDO is not doing badly in this area. The Dollar Tree seems to be hurting the most with a ratio of negative 18.36. The Family Dollars ability to pay their debts is favorable.

Debt Service Margin: (CFFO/Current Notes Payable)

The Debt Service Margin is found by taking the cash flows from operating activities of the current year divided by the notes payable of the previous year. It determines a company’s ability to pay its required payment of current debt.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A N/A N/A N/A N/A N/A Dollar Tree N/A 8.28 9.75 11.06 19.22 14.55 Dollar General 23.85 0.67 26.78 30.84 30.44 63.23 99 Cent Only N/A N/A N/A N/A N/A N/A Industry Average 23.85 4.47 18.26 20.95 24.83 38.89

Dollar General has the highest margin meaning it has the best ability to pay its installments on debt. Family Dollar and 99 Cents Only Store do not have

any notes payable on their balance sheets and were left out of this comparison analysis. Dollar Tree has an adequate debt service margin and should not have any problems covering their debt.

Overall Capital Structure Ratios Conclusion The capital structure analysis shows that for the most part Family Dollar in operating on a solid capital structure foundation. FDO’s debt to equity ratio was comparable to those in the industry except for the spike in 2006. This spike is due to liabilities from increased debt financing in order to foster company growth. It is still well below 2.0 and is no cause for alarm. The times interest earned for FDO was unavailable for all years except 2006 as there was no interest expense recognized. The 23.76 TIE for 2006 is; however, the second highest in the industry and a very good sign for lending institutions. Debt service margin was unavailable for FDO, but only because they do not have any notes payable on the balance sheet which is inherently positive. As long as Family Dollar does not deviate from their current business strategy, their capital structure will remain strong.

IGR/SGR Analysis Internal Growth Rate: (ROA (1-Dividend %))

The Internal Growth Rate (IGR) is found by taking the company’s Return on Assets multiplied by one minus the dividend percentage. The dividend percentage is the company’s annual dividends divided by its net income. The IGR is a measure of how much a company can grow its assets without using any outside financing. The greater the IGR the more a company is financing projects with retained earnings. Family Dollar’s IGR has declined over the past five years; however, this decline is inline with the rest of its competitors.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A 15.50% 14.10% 12.99% 9.78% 8.10% Dollar Tree N/A 11.03% 10.45% 9.91% 10.02% 9.28% Dollar General N/A 22.11% 12.82% 13.13% 12.33% 4.63% 99 Cent Only N/A 17.25% 13.34% 5.03% N/A 1.94% Industry Average N/A 16.47% 12.68% 10.26% 10.71% 5.99%

The decline is, in all probability, due to the industry’s need to grow in order to stay competitive. The industry, as previously stated, is highly concentrated, thus the only way to gain market share is aggressive acquisitions. To fund these large purchases all firms in the industry must seek outside financing or lose market share. As long as FDO’s IGR decline stays above or inline with its competitors this decline should not turn off investors.

Sustainable Growth Rate: IGR (1+ (Total Debt/Total Equity))

This ratio uses the debt to equity ratio in its formula along with the Internal Growth Rate. The Sustainable Growth Rate (SGR) is a growth rate that is found by taking the company’s Internal Growth Rate times one plus the total debt divided by the total equity. Investopedia.com states that this rate “is the maximum growth rate that a firm can sustain without having to increase financial leverage.” This rate tells you how much a firm can grow without putting on more debt for the company.

Company 2001 2002 2003 2004 2005 2006 Family Dollar N/A 23.54% 21.36% 21.61% 16.50% 16.91% Dollar Tree N/A 14.39% 15.24% 15.25% 15.38% 14.89% Dollar General 22.28% 40.05% 21.61% 22.15% 21.35% 8.06% 99 Cent Only N/A 19.13% 15.07% 6.18% N/A 2.43% Industry Average 22.28% 24.28% 18.32% 16.30% 17.74% 10.57%

Family Dollar’s sustainable growth rate has slowly gotten smaller, which is not good. In 2002, FDO’s sustainable growth rate was 23.54%. This rate fell to 16.91% in 2006. Family Dollar is only able to grow so much now before having to borrow funds to keep operating. 99 Cent Only Stores had the worst sustainable growth rate out of its competitors. In 2006, 99 Cent Only Stores had a SGR of only 2.43%. This is very low. The industry average went up and down over the past six years. The best industry average was in 2002 with an average of 24.28%. This rate has slowly gone down to a 10.57% sustainable growth rate.

Financial Statement Analysis Financial Statement Forecasting

When performing a fundamental analysis, forecasting income statements, balance sheets, and statements of cash flows is an essential key in determining the intrinsic value of a security. Forecasting future trends of an industry or firm focuses on analyzing current and past data that can be gathered from sources such as 10’K reports. We forecasted future trends of Family Dollar Inc.’s financial statements for the next ten years dating to 2016. Our analysis was based on the most recent six years of FDO’s activity dating back to 2001. When computing our forecasts’, we also analyzed Dollar Tree’s, Dollar General’s, and 99 Cent Only Store’s financial data for the same period. In doing so, we were able to make assumptions by recognizing and comparing trends across the industry to FDO.

Income Statement

Actual Financial Statements Forecast Financial Statements (in thousands) 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Years ended 2001 31-Aug-02 30-Aug-03 28-Aug-04 27-Aug-05 26-Aug-06 Net sales $3,665,362 $4,162,652 $4,750,171 $5,281,888 $5,824,808 $6,394,772 10.42% $7,061,107 $7,796,875 $8,609,309 $9,506,399 $10,496,966 $11,590,750 $12,798,506 $14,132,110 $15,604,676 $17,230,683 Cost of sales $2,439,261 $2,766,733 $3,145,788 $3,496,278 $3,908,569 $4,276,466 66.57% $4,700,579 $5,190,379 $5,731,217 $6,328,410 $6,987,830 $7,715,962 $8,519,965 $9,407,746 $10,388,033 $11,470,466

Gross Profit $1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306 $2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217

Selling, general and administrative $927,679 $1,054,298 $1,214,658 $1,382,248 $1,577,429 $1,756,001 25.89% $1,828,121 $2,018,611 $2,228,950 $2,461,207 $2,717,664 $3,000,845 $3,313,533 $3,658,803 $4,040,051 $4,461,024 Litigation charge (Note 8) $0 $0 $0 $0 $0 $45,000 Cost of sales and operating expenses $3,366,940 $3,821,031 $4,360,446 $4,878,526 $5,485,998 $6,077,467 $6,528,700 $7,208,990 $7,960,167 $8,789,616 $9,705,495 $10,716,807 $11,833,498 $13,066,549 $14,428,083 $15,931,490

Operating profit $298,422 $341,621 $389,725 $403,362 $338,810 $317,305 7.54% $532,407 $587,884 $649,142 $716,782 $791,471 $873,943 $965,007 $1,065,561 $1,176,593 $1,299,193

Interest income $0 $0 $0 $3,300 $3,985 $6,934 Interest expense $0 $0 $0 $0 $0 $13,095

Income before income taxes $298,422 $341,621 $389,725 $406,662 $342,795 $311,144

Income taxes $108,917 $124,692 $142,250 $148,758 $125,286 $116,033

Net income $189,505 $216,929 $247,475 $257,904 $217,509 $195,111 4.54% $320,574 $353,978 $390,863 $431,591 $476,562 $526,220 $581,052 $641,598 $708,452 $782,273

Forecasting out the income statement was our first step in the process. We started by evaluating the first line item in the income statement, net sales. We noticed that the sales growth percentage from year to year was fairly consistent. The average sales growth percentage rate from 2001 to 2006 equaled 11.79%. We chose to assume that sales would grow at a slightly less rate of 10.42% for the next ten years. We were conservative with our assumption in order to factor in a slowing economy. Also, observing that Yahoo! Finance predicted a 5-year future sales growth rate of 10.96% influenced our assumed future growth rate. Next, we forecasted FDO’s cost of sales. Cost of sales has consistently accounted for an average of 66.57% of sales for the past 6 years. Thus we chose to assume that this will hold true for years to come. Gross profit was then

forecasted as the difference of sales and cost of sales. Gross profit averaged 33.43% in the past which also gave reason for our previous assumptions. Like cost of sales, the common size income statement revealed that selling, general, and administrative expenses, accounted for 25.89% of sales on average with little variance from ’01 to ’05. In the year 2006 there was an increase in S,G,&A in comparison to previous years. After reading FDO’s 2006 10-K, we learned that it was a onetime litigation charge from a court ruling against FDO. Being that, we chose to leave fiscal year 2006 out of the average. Our assumed rate for the S,G,&A forecast was that of the average because of the consistency across the common size income statement. Net income was forecasted under the same circumstances. The average, 4.58% of sales, from the common size statement for the periods of 01-05 was used to forecast the net income. We chose to assume that this rate would hold true because the FDO 10k spoke of offsetting certain expenses with the continuing growth of sales. For example, the 2007 10-K stated that FDO would continue to open new distribution centers to more efficiently deliver freight due to higher fuel costs. Our assumption rate for forecasting out operating profit was also derived from the average percent (7.54%) of total sales that it represented on the common size income statement. We also viewed the forecasted statement in a similar way as common size income statement to check for errors. We reassured the credibility of all our forecasted values by applying simple accounting rules to confirm that our numbers added up.

Income Statement (Revised): Because we treated the operating leases as financing expenses, Operating Income increased by the reversal of the Operating Lease Rent that is reported by Family Dollar in each year. The expense is usually not a line item listed and is therefore embedded into COGS or SGA expenses. Also, assuming capitalizing the operating leases, an estimated interest and depreciation expense can be derived

by using given long-term rate of borrowing (the same to calculate the PV of all future operating leases). This Inputed interest expense is subtracted from gross profit. Operating Income will still be higher than using the original operating lease method. Net Income stays the same because operating lease expenses will be equal to the sum of all the imputed interest expense and the depreciation of the capitalized lease. These are the assumptions we believed to be most accurate in our revised Income Statement.

Balance Sheet

Actual Financial Statements Forecast Financial Statements 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (in thousands, except per share and share amounts) Assets Current assets: Cash and cash equivalents $21,753 $220,265 $206,731 $87,023 $105,175 $79,727 Investment securities (Note 2) $0 $0 $0 $120,840 $33,530 $136,505 Merchandise inventories $721,560 $766,631 $854,370 $980,124 $1,090,791 $1,037,859 3.76 $1,250,154 $1,380,420 $1,524,260 $1,683,088 $1,858,465 $2,052,118 $2,265,948 $2,502,060 $2,762,775 $3,050,656 Deferred income taxes (Note 6) $43,985 $49,941 $61,769 $84,084 $100,493 $133,468 Income tax refund receivable $4,936 $6,469 $0 $1,304 $0 $2,397 Prepayments and other current assets $15,031 $12,553 $33,622 $16,937 $24,779 $28,892 Total current assets $807,265 $1,055,859 $1,156,492 $1,290,312 $1,354,768 $1,418,848 57.76% $1,664,692 $1,838,153 $2,029,689 $2,241,182 $2,474,713 $2,732,578 $3,017,313 $3,331,717 $3,678,882 $4,062,221

Property and equipment, net (Note 3) $580,879 $685,617 $812,123 $918,449 $1,027,475 $1,077,608 41.35% $1,191,742 $1,315,921 $1,453,041 $1,604,447 $1,771,631 $1,956,235 $2,160,074 $2,385,154 $2,633,687 $2,908,117 Other assets $11,601 $13,143 $17,080 $15,600 $27,258 $26,573 $25,651 $28,323 $31,275 $34,533 $38,132 $42,105 $46,493 $51,337 $56,686 $62,593 Non-Current Assets $592,480 $698,760 $829,203 $934,049 $1,054,733 $1,104,181 42.24% $1,217,393 $1,344,245 $1,484,315 $1,638,981 $1,809,763 $1,998,340 $2,206,567 $2,436,491 $2,690,373 $2,970,710

Total Assets $1,399,745 $1,754,619 $1,985,695 $2,224,361 $2,409,501 $2,523,029 2.45 $2,882,085 $3,182,398 $3,514,004 $3,880,163 $4,284,476 $4,730,918 $5,223,880 $5,768,208 $6,369,255 $7,032,932

Liabilities and Shareholders Equity Current liabilities: Accounts payable $264,965 $381,164 $401,799 $534,405 $574,831 $556,531 Accrued liabilities (Note 5) $12,329 $149,616 $192,861 $266,180 $315,508 $429,580 Income taxes payable $0 $0 $671 $0 $4,272 $0 Total current liabilities $390,294 $530,780 $595,331 $800,585 $894,611 $986,111 26% $749,342 $827,423 $913,641 $1,008,842 $1,113,964 $1,230,039 $1,358,209 $1,499,734 $1,656,006 $1,828,562 Long-term debt (Note 4) $0 $0 $0 $0 $0 $250,000 Deferred income taxes (Note 6) $50,436 $68,891 $79,395 $86,694 $86,824 $78,525

Non-Current Liabilities (forecast plug) $50,436 $68,891 $79,395 $86,694 $86,824 $328,525 $680,705 $633,905 $582,228 $525,167 $462,159 $392,586 $315,764 $230,937 $137,271 $33,845

TOTAL LIABILITIES Forecast plug $440,730 $599,671 $674,726 $887,279 $981,435 $1,314,636 $1,430,047 $1,461,328 $1,495,869 $1,534,009 $1,576,123 $1,622,625 $1,673,973 $1,730,671 $1,793,277 $1,862,407

Shareholders equity: (Notes 9, 10 and 11) Preferred stock, $1 par; authorized and unissued 500,000 shares

Common stock, $.10 par; authorized 600,000,000 shares; issued 178,559,411 shares at August 26, 2006, and 188,871,738 shares at August 27, 2005, and outstanding 150,210,484 shares at August 26, 2006, and 165, 262,513 shares at August 27, 2005 $18,454 $18,583 $18,691 18,767 $18,887 $17,856 Capital in excess of par $40,318 $63,294 $87,457 106,853 $133,743 $140,829 Retained earnings $945,192 $1,118,015 $1,315,600 1,498,890 $1,654,861 $1,546,366 $1,790,010 $2,059,042 $2,356,108 $2,684,127 $3,046,326 $3,446,266 $3,887,880 $4,375,510 $4,913,951 $5,508,498 Total $1,003,964 $1,199,892 $1,421,748 $1,624,510 $1,807,491 $1,705,051

Less: common stock held in treasury, at cost (28,348,927 shares at August 26, 2006, and 23,609,225 shares at August 27, 2005 $44,949 $44,944 $110,779 287,428 $379,425 $496,658 Total shareholders equity $959,015 $1,154,948 $1,310,969 $1,337,082 $1,428,066 $1,208,393 $1,452,037 $1,721,069 $2,018,135 $2,346,154 $2,708,353 $3,108,293 $3,549,907 $4,037,537 $4,575,978 $5,170,525

Total Liabilities and Shareholders Equity $1,399,745 $1,754,619 $1,985,695 $2,224,361 $2,409,501 $2,523,029 $2,882,085 $3,182,398 $3,514,004 $3,880,163 $4,284,476 $4,730,918 $5,223,880 $5,768,208 $6,369,255 $7,032,932

To forecast the FDO balance sheet we began by looking at the profitability ratio, asset turnover. The average asset turnover ratio for FDO for the past six years is 2.45. We assessed the average asset turnover ratio for FDO’s competitors to make an assumption. We noticed that Family Dollar and Dollar General continually produced a higher asset turnover ratio in comparison to Dollar Tree and 99 Cent Only. Because of the similar movements in the asset turnover ratio for FDO and Dollar General, we assumed that the FDO 2.45 average ratio is a feasible ratio to assume for forecasting total assets. We

divided our forecasted sales from the income statement by 2.45 in order to compute total assets. From forecasting total assets we headed to merchandise inventories because of the pattern in the common size balance sheet. The 2001 to 2006 average inventory turnover ratio was used to compute and forecast inventories. By dividing the forecasted cost of sales by the FDO inventory turnover average 3.76, we were able to forecast merchandise inventories out to 2016. We assumed that 3.76 was the best ratio to use because it was lower than the industry average and FDO’s inventory turnover ratio has been below the industry average for the past six years. The common size balance sheet revealed to us that current assets have accounted for, close to, 57.76% of total assets. Being that, thus, we assumed that rate to forecast out current assets. Property and equipment were forecasted out using an assumed rate of 41.35% of noncurrent assets. This rate was derived from analyzing the obvious trend in the common size balance sheet. Using the principles of balancing our balance sheet we were able to forecast out the total noncurrent assets as well as the line item, other assets. Retained earnings, shareholders’ equity and liabilities were the last items to forecast. Retained earnings for each year were calculated by adding net income to the beginning balance of retained earnings (previous year) and subtracting out dividends. Shareholder’s equity for year t was forecasted using the same principal: S.E.t=S.E.t-1 + N.I.t – Div.t. We used simple math to forecast out total liabilities remembering that assets are equal to the sum of liabilities and shareholders’ equity. Current liabilities were calculated as an assumed percentage of total liabilities and equity rather than using the current ratio. Adding and subtracting line items was the final process in filling in the blanks.

Balance Sheet (Revised): Based on the simple assumption that all future operating lease expenses can be discounted back using an accurate PV factor to produce a capital lease, there will

only be a small adjustment needed on the Balance Sheet. The PV of all future operating lease payments will create a single value that will be added to the long-term liabilities section and the long-term assets section.

Statement of Cash Flows

Actual Financial Statements Forecast Financial Statements 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Cash flows from operating activities: Net income $189,505 $216,929 $247,475 $257,904 $217,509 $195,111 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 67,685 $77,015 $88,315 102,010 114,733 134,637 31.13% $153,486 $174,974 $199,471 $227,397 $259,232 $295,525 $336,898 $384,064 $437,833 $499,129 Deferred income taxes 24,281 $12,499 ($1,325) (1,496) (16,279) (41,274) Stock-based compensation expense, including 0 $10,123 $6,815 4,476 3,700 7,931 tax benefits Loss on disposition of property and equipment (809) $2,287 $3,905 4,311 3,306 5,603 Changes in operating assets and liabilities: Merchandise inventories (76,946) ($45,071) ($87,739) (125,754) (110,667) 52,932 Income tax refund receivable (4,936) ($1,533) $6,469 (1,304) 1,304 (2,397) Prepayments and other current assets (4,094) $2,478 ($21,069) 16,685 (7,842) (4,113) Other assets (6,144) ($1,542) ($3,937) 1,480 (11,658) 1,968 Accounts payable and accrued liabilities (15,455) $139,541 $62,233 121,608 100,974 104,867 Income taxes payable (7,177) $0 $671 (671) 4,272 (4,272) CASH FLOW FROM OPERATIONS 165,910 $412,726 $301,813 376,477 299,352 450,993$ 493,049 $ 562,076 $ 640,767 $ 730,474 $ 832,740 $ 949,324 $ 1,082,229 $ 1,233,741 $ 1,406,465 $ 1,603,370 Cash Flow From Investing (160,170) ($184,040) ($218,727) ($216,585) ($139,755) ($293,348) ($113,212) ($126,852) ($140,070) ($154,666) ($170,782) ($188,577) ($208,227) ($229,924) ($253,882) ($280,337) Cash Flow From Financing (27,545) ($30,147) ($96,621) ($216,408) ($141,445) ($236,909)

2001 2002 2003 2004 2005 2006 Avg. 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Avg. CFFO/Operating Income 0.56 1.21 0.77 0.93 0.88 1.42 0.96 0.93 0.96 0.99 1.02 1.05 1.09 1.12 1.16 1.20 1.23 1.07 CFFO/Net Income 0.88 1.90 1.22 1.46 1.38 2.31 1.52 1.54 1.59 1.64 1.69 1.75 1.80 1.86 1.92 1.99 2.05 1.78 CFFO/Sales 0.05 0.10 0.06 0.07 0.05 0.07 0.07 0.07 0.07 0.07 0.08 0.08 0.08 0.08 0.09 0.09 0.09 0.08

Forecasting the cash flow statement was the most difficult statement to forecast because of lack of pattern. For this reason, we concluded that the cash flows from operations and cash flow from investing activities were the most necessary items to forecast for our analysis. To go about forecasting CFFO, we studied the cash flow statement and noticed a trend in the yearly percent growth of depreciation and amortization. The average growth rate for this line item came out to 14% over the last six years. Each individual year’s percent growth showed little deviation from the mean of 14%. We were assuming that with plans of future growth, as stated in the FDO 10K, at a steady rate, we were making a good decision by choosing to forecast out the depreciation and amortization. Depreciation and amortization accounted for an average of 31.13% of the CFFO for the past 4 years on the common size cash flow statement. By 94

assuming the average would hold true for future periods, we were able to forecast out 10 years worth of CFFO by dividing our forecasted depreciation and amortization by 31.13%. Cash flow from investing activities was forecasted by computing the year to year change in forecasted non-current assets. We checked our assumptions by using expense diagnostic ratios. We calculated that the average CFFO/Operating Income from 2001 to 2006 was .96. Our forecasted average was equal to 1.07. We were pleased with this number especially because it is averaging in four extra years of CFFO/OI as compared to .96. Next, we computed the FDO 2001 to 2006 average CFFO/Net Income ratio to equal 1.52. For 2007 to 2016, we averaged a ratio of 1.78. Again, we were pleased with this number which boosts our confidence in our forecasted Family Dollar cash flow statement.

Conclusion To the best of our ability, using financial ratios, common sized financial statements, and our, along with other analysts’, opinions we completed the forecasting portion of our Family Dollar valuation analysis. We reassured the credibility of all our forecasted values by applying simple accounting rules to confirm that our balance sheets balanced, our sales minus costs of goods sold equaled gross profit, and so on.

Cost of Capital Estimate

A company’s assets are either financed by equity or debt. The Weighted Average Cost of Capital (WACC) is a good method for a company to use. In this model, the debt and equity portions are weighted by the appropriate cost of capital. To find the WACC, there are many components that are needed. The first step in finding out the WACC of a company is to first estimate the cost of

equity, or ke.

Cost of Equity CAPM is a pricing model that computes the cost of equity for a firm. There are several figures needed in order to compute CAPM. The risk free rate is the first of these figures and we attained ours from the latest entry in 5 Year Treasury Constant Maturity Rate table from the St. Louis FED FRED data as 4.20%. Our beta of .75 was extracted from our 5 year, 72 month regression summary table as this model had the highest adjusted R² of 10.53%. This .75 beta was the result of 25 separate regression models. The large number of regressions which were performed over varying time periods (24 months, 36 months, 48 months, 60 months, and 72 months) and with different constant maturity t-bill rates from FED FRED data (3 month, 1 year, 2 year, 5 year, and 7 year), were necessary to check the stability of beta. Once all the regressions were run we looked for the regression with the highest adjusted R². This R² value is explains the proportion of the variance in the dependent variable that can be predicted by the independent variable. The higher the adjusted R² the more explanatory power it has. Our 72 month, 5 year t-bill rate regression gave us the highest adjusted R² of 10.53% and a corresponding beta of .75. This was lower than our published beta, which according to Google Finance is .86. While,

10.53% is a relatively low explanatory power, our beta is almost perfectly constant across all of the models. Despite this, with the greatest adjusted R² at less than 11%, there will be substantial error in FDO’s CAPM model.

5 Year Time Period Adjusted (months) R² Est. Beta ke 72 10.53% 0.75 9.61% 60 7.01% 0.85 10.43% 48 5.69% 1.01 11.72% 36 4.75% 1.02 11.74% 24 8.06% 1.26 13.69%

Finally our unadjusted market risk premium (MRP) of 6.80% is the average MRP of the market from 1926-2005. This raw MRP, however, must be adjusted by an additional 1.1% from table 8-1 (Palepu pg. 8-4) to account the added risk premium of a company with a $3.03 billion market cap. This translates to final MRP of 7.90%. Once all values have been attained they were simply plugged into the following equation:

Ke=Rf+ β (Rm-Rf)

Ke= cost of equity Rf= the risk-free rate β = beta Rm= the return on the market

These calculations ultimately produce a cost of equity of 10.11%. This means that FDO’s stockholders require at least a 10.11% return on their investments in FDO as compensation for both risk and the time value of money.

Cost of Debt

Now that we have found our cost of equity, ke, we can know find our

weighted average cost of debt before taxes, or kd. We did this by identifying each part of our liabilities, long-term and short-term. Then, we found the weight of each liability by dividing it by Family Dollar’s value of debt, which is $1,314,636,000. Our average interest rate that we chose to use for current liabilities was the published 3 month commercial paper rate in Oct. of 2007 (federalreserve.gov). The long term debt interest rate was disclosed in the FDO 2007 10K. For deferred income taxes we used the 2 year treasury constant maturity rate also published in October 2007 (federalreserve.gov). Next we calculated the weighted average interest rate for each liability by multiplying its weight by the appropriate interest rate. The sum of the computed weighted average interest rate for each liability yielded a before tax weighted average cost of debt of 4.724%. Our summarization of calculations are displayed in the following table.

Balance Sheet (in Avg Int. Weight*Avg Int. thousands) 2006 Weight Rate Rate Current Liabilities 986111 0.750102 4.63 3.472971933 LT Liabilities LT Debt 250000 0.190167 5.33 1.013588552 Deferred Inc. Taxes 78525 0.059731 3.97 0.237133511 Value of Debt 1314636 Before Tax Weighted Avg. Cost of Debt 4.724

Market Value of Equity 3030

Weighted Average Cost of Capital

Determining the weighted average cost of capital before tax is now easy to do. The formula for the before tax WACC is shown below.

WACCBT= (Vd/Vf) (kd) + (Ve/Vf) (ke) So,

WACCBT= (1315/4345) * (.04724) + (3030/4345) * (.1011)

All of the numbers in the above formula can be found in the table

provided above. The kd and ke that we found are 4.724 % and 10.11%, respectively. When solved, Family Dollar’s weighted average cost of capital before taxes is 8.48%.

In order to find the after-tax weighted average cost of capital is found just like the before tax weighted average cost of capital but it takes into account

taxes. We used our current tax rate of 37.3%, which was provided in Family Dollar’s 2007 10K.

WACCAT= (Vd/Vf) ((kd)(1-t)) + (Ve/Vf) (ke) So,

WACCAT= (1315/4345) * (.04724*(1-.373)) + (3030/4345) * (.1011)

When solved, the weighted average cost of capital after taxes equals 7.95%.

Revised Cost of Debt The changes in liabilities, as a result from capitalization of operating leases, affected our cost of debt by causing a minor increase to 4.989%. Specifically there was an increase in long-term liabilities due the addition of capital lease rights on the balance sheet.

Balance Sheet (in thousands) 2006 Weight Avg Int. Rate Weight*Avg Int. Rate Current Liabilities 986111 0.421425485 4.63 1.951199996 LT Liabilities LT Debt 1275306 0.545015984 5.33 2.904935196 Deferred Inc. Taxes 78525 0.033558531 3.97 0.133227367 Value of Debt 2339942

Before Tax Weighted Avg. Cost of Debt 4.989

Market Value of Equity 3030

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Revised WACC

WACCBT= (2340/5370) * (.04989) + (3030/5370) * (.1011)

Our adjusted weighted average cost of capital before tax is 7.87%. This lease adjusted rate is .61% lesser than the original WACC before tax of 8.48%.

WACCAT= (2340/5370) * (.04989*(1-.373)) + (3030/5370) * (.1011)

Our adjusted weighted average cost of capital is equal to 7.067%.

7.067% is only .09% less than the original WACCAT.

Analysis of Valuations

Conducting an evaluation analysis is a very important step in valuing a company. After looking at how the industry and the company operate and how the company reports its numbers, the valuation is the decisive factor in whether or not an investor should invest in a company or not. During the valuation process, an investor will reveal if the company’s share price is overvalued, undervalued, or fairly valued. In doing this there are two methods to the valuation process to take into account. The first method is the method of comparables. This method is the less reliable of the two when it comes to making accurate assumptions about the company because it’s not based on financial theory. Many people use the Method of Comparables because it is quick and implement. The method of comparables involves taking ratios of FDO’s competitors, then taking an industry average as a benchmark. After an industry average is derived, the computed share price is compared to the benchmark of the given ratio. These ratios include: Trailing and forward price to earnings, price to book, dividends earnings, P.E.G, Price over

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EBITDA, Price over Free Cash Flow per Share, and Enterprise Value over EBITDA. The second method of the valuation analysis is the intrinsic valuation method. With this method there is more accuracy in an overvalued, undervalued, or fairly valued assumption because of the elaborate forecasts and analysis of assenting years. There are many different models to look at when deriving instrinsic value including: Discounted Dividends, Discounted Free Cash Flows, The Residual Income Method, The Residual Income Perpetuity, and the Abnormal Earnings Approach. All of these have their own separate methods and calculations for coming up with an intrinsic value.

Method of Comparables

The Method of Comparables involves taking an industry average of each ratio and comparing that average to the share price of the company being valued. For valuing Family Dollar, we only took the averages of the 99 Cents Only and The Dollar Tree because; our other competitor The Dollar General, recently went private.

Trailing Price to Earnings

Trailing P/E is found by taking the current share price and dividing it by the last years’ Earnings per Share.

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P/E (Trailing) Company P/E (Trailing) Est. Stock Price Family Dollar $60.646 Dollar General NA Dollar Tree 14.732 99 Cent Only 58.645 Average 36.689 UNDERVALUED

We took the P/E ratio for The Dollar Tree and 99 Cents Only and added them up. We then divided by two to get the average to get 36.8. We then set this number equal to the trailing P/E of Family Dollar and solved to get an estimated share price of 60.65. When compared to FDO’s current stock price of 23.24, it shows that our company is undervalued when this method is used.

Forward Price to Earnings

The Forward Price to Earnings Ratio is a calculated by dividing Market Price per Share by the Expected Earnings per Share. It is important to note that the forecasted earning per share is used in this calculation.

P/E (Forecast) EPS P/E Company (Forecast) (Forecast) Est. Stock Price Family Dollar $31.142 Dollar General NA Dollar Tree 2.45 11.707 99 Cent Only 0.35 25.971 Average 18.839 UNDERVALUED

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The industry average was calculated by using The Dollar Tree’s and 99 Cent Store’s average P/E forecast, which was 18.84. After taking the average, we set it equal to Family Dollar’s P/E forecast and solved for P by multiplying FDO’s P/E by the industry P/E. The equated share price using this method came out to be $31.14. When compared to FDO’s current share price of 20.23, it is assumed that the price is undervalued. This is because there is a significant difference in the two prices and the forecasted share price is larger than the actual.

FDO’s Forecast P/E = Industry Average P/E

FDO’s ‘P’ = Industry Average (P/B) * (FDO’s ‘E’)

Price to Book Value

The Price to Book compares the current stock price (market value) to the firm’s book value, so to calculate this ratio you take the current share price and divide it by the book value of the company at the end of the last quarter.

P/B Company Est. Stock Price Family Dollar $ 15.31 Dollar General NA Dollar Tree 2.521804115 99 Cent Only 1.214428858 Average 1.868116486 OVERVALUED

After computing this ratio for our competitors and dividing that number by two (the number of competitors in the industry) we got the average of 1.87. We

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then took FDO’s P/B and set it equal to the industry average P/E and solved for P by multiplying industry average P/B by FDO’s B. This computation yielded a stock price of 15.31, when compared to FDO’S current share price, shows that FDO is overvalued.

FDO’s P/B = Industry Average P/B

FDO’s ‘P’ = (Industry Average P/B )*( FDO’s ‘B’)

Dividend Yield

The Dividend Yield is used to compute the dividends paid by a company compared to the share price. Since none of FDO’s competitors pay dividends, we cannot take an industry average to compute the dividend yield.

PEG

The PEG ratio is used to value a stock price relative to earnings growth. This can be calculated by taking the P/E ratio and dividing it by the earnings growth.

PEG industry average 1.07 g 13.88% PEG ratio $ 22.09 UNDERVALUED

By taking the PEG of our two competitors and dividing it by two we came up with an industry average of 1.07. The industry PEG was then set equal to the FDO’s PEG and solved for P by multiplying the industry average P.E.G by the

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FDO’s E*G to derive a price of 22.09, which makes the current price of 20.23 slightly undervalued.

FDO’s P/ (E/G) = Industry Average P.E.G.

FDO’s ‘P’ = (Industry Average P.E.G )* (FDO’s ‘E’ * ‘G’)

P/EBITDA

P/ EBITDA are used to calculate the estimated price per share for the firm. This is calculated by dividing the current price by the EBITDA.

P/EBITDA Company Est. Stock Price Family Dollar $3.971920172 Dollar General Dollar Tree 0.058358087 99 Cent Only 0.279778393 Average 0.16906824 OVERVALUED

The first step to this computation was to take the average P/EBITDA for the industry. After the average was calculated, we set it equal to Family Dollar’s P/EBITDA and solved for P by multiplying the industry average P/EBITDA by FDO’s EBITDA. According to this calculation our estimated stock price was 3.97. When compared to our actual share price of 20.23, we can see that FDO is extremely overvalued using this ratio. The industry average P/EBITDA of .169 was computed and set equal to FDO’s P/EBITDA to get an estimated stock price of 3.971. When compared to the current stock price of 20.23, it is assumed that FDO is overvalued.

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FDO’s P/EBITDA = Industry Average P/EBITDA

FDO’s ‘P’ = (Industry Average P/EBITDA )*( FDO’s EBITDA)

Price/ Free Cash Flows

The Price to Free Cash Flow model is used to compare the share price to the annual cash flows. To calculate P/FCF, take the current share price and divide it by the free cash flows.

P/FCF Company Est. Stock Price Family Dollar $37.86 Dollar General n/a Dollar Tree 6.696806257 99 Cent Only 7.593902812 Average 7.145354534 UNDERVALUED

To find an estimated share price using this method, we first took the price to cash flows of our competitors, added them up and divided by two, to get an industry average of 7.15. We then set that equal to FDO’s P/FCF. We then multiplied the industry P/FCF by Family Dollar’s P/FCF to get 37.86, and when compared to FDO’s current share price of 20.23, the price is undervalued.

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FDO’s P/FCF = Industry Average P/FCF

FDO’s ‘P’ = Industry Average P/FCF * FDO’s FCF

Enterprise Value/EBITDA

Enterprise Value/EBITDA is calculated by taking the sum of the price per share and the book value of liabilities, and the subtracting its cash and cash equivalents.

Enterprise Value/EBITDA Company Est. Stock Price Family Dollar $31.85 Dollar General n/a Dollar Tree 6.203 99 Cent Only 14.39 Average 20.593 UNDERVALUED

To find an estimated share price using this method, first an industry average is needed. This is found by calculating the Enterprise Value/EBITDA for the competitors and dividing that number by two. The calculated industry average by doing this is 20.593. To find the estimated share price, we took the industry average and multiplied it by FDO’s Enterprise Value/EBITDA. We then subtracted the book value of liabilities and added cash to get 4,474,275. Next, we divided this by the total number of shares outstanding, and derived the estimated stock price of 31.85. When compared to FDO’s current share price of 20.23, the price of the stock is undervalued.

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Overall Method of Comparables Valuation The overall assumption using The Method of Comparables is that Family Dollars’ stock price of 20.23 is undervalued. Out of all the ratios, only the P/Book Value and the P/EBITDA showed the price to be overvalued. The rest of the ratios showed the price to be undervalued. There are many reasons why these estimations and assumptions are not reliable. One, for example is the calculations are made on the surface content of information like pre- computed numbers without ever taking into account the reasoning behind those numbers. The companies' accounting strategies, industry overviews, and other crucial underlying information is left out of the calculation and assumption. These calculations are also based on past information and have no insight to forward looking predictions. The same holds when comparing and averaging the competitor’s numbers, which can cause a certain level of distortion. To better analyze whether or not the price is overvalued or undervalued, we need to look at the Intrinsic Valuations that take into account forward looking estimations.

Intrinsic Valuations

Intrinsic Value is defined as “the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors” (Investopedia.com). The Intrinsic Valuation models explain better of how much value is in a company. These models go more in-depth and are extremely more reliable than the previous values from the Method of Comparables. The intrinsic valuation models include the Discounted Dividends model, the Free Cash Flow model, the Residual Income model, the Long Run Return on Equity Residual Income model, and the Abnormal Earnings Growth model.

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Discounted Dividends Model

The purpose of the Discounted Dividends Model is to value a firm based on the present value of all predicted future dividend payments. According to investopedia.com the DDM is “one of the oldest, most conservative methods of valuing stocks.” Many assumptions such as future dividend payments, risk- adjusted discount rates and growth rates are needed to use the model. The main point behind the DDM is that a stock is not more valuable than all current and future generated dividends that a shareholder will receive as a return.

Sensitivity Analysis g 0 0.03 0.05 0.07 0.1

0.06 $19.62 $33.46 $88.82 N/A N/A ke 0.08 $14.24 $19.58 $29.09 $76.61 N/A 0.09 $12.47 $16.14 $21.65 $38.18 N/A 0.1011 $10.93 $13.47 $16.82 $24.48 $558.20 0.12 $8.99 $10.46 $12.14 $15.17 $31.05

0.14 $7.53 $8.43 $9.35 $10.81 $15.72

<19.24 >27.24 overvalued undervalued

November 2007 share price $23.24

In order to value Family Dollar using the DDM, we started by forecasting out dividends. After studying the FDO 10k reports, we calculated the percentage of net income that dividends represented for years 2001 to 2006. We were pleased to observe a trend with an average of 24% dividends of net income for the past 6 years. Assuming a 24% average for the next ten years, we were able to forecast out future dividends for 2007 to 2016. Satisfied with the results, we discounted back the future dividend payments, using our cost of equity 10.11%, to present values. The sum of the present value of each year’s dividends was then computed, yielding $707,582. For infinite number of future years,

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beginning in 2017, we used the perpetuity equation to value FDO. We chose to cut our future dividend growth rate in half to a conservative 5% for the perpetuity. A conservative 5% growth rate was assumed to account for unforeseen factors that can affect distant future activity. Dividing the terminal year’s dividends by the difference of the cost of equity minus 5% growth gave us our perpetuity in 2016 dollars. The present value of the perpetuity $3,857,390 equaled a value of $1,472,400. Adding the present value of the perpetuity to the present value of 2007-2016 dividends gave us a total value of FDO. By dividing the total dollar figure by year 2007 shares outstanding 140,473, the DDM provided us with an FDO share value of $15.52 at the end of 2006 (FDO10K 2007). FDO’s observed share price, along with total shares outstanding, were obtained November 4, 2007 which prompted us to grow $15.52 into current dollars. Being that, thus, the DDM provided us with a November 4, 2007 implied share price of $16.82. The observed stock price per share as of November 4, 2007 equaled $23.24 (yahoo finance). According the discounted dividends model, Family Dollar inc. stock is trading for $6.42 per share over its true value of $16.82 per share. Investors who observe the FDO figures from the DDM would say that Family Dollar inc. is overvalued. Noting that 68% of the estimated total value of FDO is derived from the much speculated perpetuity should be an indicator of the DDM lack of explanatory power.

Free Cash Flow Model

The Discounted Free Cash Flow Model is another intrinsic valuation model that is similar the Discounted Dividend Model. This model explains a company’s stock price in terms of its forecasted cash flows to the firm and the cost of capital.

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Sensitivity Analysis g 0 0.01 0.03 0.05 WACC 0.07 $91.76 $103.00 $142.33 $260.31 0.0848 $70.23 $76.71 $96.78 $139.92 0.09 $64.44 $69.88 $86.22 $118.90 0.1 $55.11 $59.08 $70.45 $90.90 0.11 $47.60 $50.57 $58.74 $72.37

< 19.24 overvalued > 27.24 undervalued Fairly valued

In order to do the Free Cash Flow Model for Family Dollar we used our FDO forecasted cash flow from operations (CFFO), forecasted cash flow from investing (CFFI), the company’s before tax weighted average cost of capital (WACC), and an observed share price. By subtracting the CFFO and the CFFI we determined the free cash flows to the firm. Free cash flow to the firm is the amount of money the company has left over after sustaining or expanding its assets. Then, using our WACCbt, we computed the present value of annual free cash flow to the firm and summed the figures for a total present value of free cash flows. Next, we calculated the value of equity by taking the value of the firm and subtracting the book value of Family Dollar’s liabilities. The estimated value of the firm was equal to the sum of our total present value of free cash flows and present value of the terminal year’s free cash flow figure. Once we computed market value of equity, we knew how to find the company’s estimated value per share by dividing by shares outstanding. The estimated value per share was compared to the company’s observed share price of $23.24. Our final step was constructing a sensitivity analysis table by varying Family Dollar’s WACC and growth rate to observe stock price changes.

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In conclusion, the free cash flow model does a poor job of explaining a company’s stock price, especially for Family Dollar. This could be a result of estimation errors in forecasting. The Free Cash Flow model states that Family Dollar is extremely undervalued relative to its current share price of $23.24.

Residual Income Model

The Residual Income Model is another valuation model that is used in valuation analysis. This model is based on foundations in financial theory and is consistent with the Modigliani and Miller Model. The RI model helps determine if a company is overvalued, undervalued, or fairly valued as do the previous valuation models. The Residual Income model has the highest degree of explanatory power in comparison to the previous valuation models we used, with potential for explaining 50% or stock price variability.

Sensitivity g Analysis 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.08 44.93 33.40 30.10 28.54 27.63 27.03 0.09 37.76 29.69 27.19 25.97 25.25 24.77 0.1011 31.62 26.18 24.35 23.44 22.89 22.52 0.12 24.06 21.33 20.31 19.78 19.45 19.23 0.13 21.07 19.23 18.51 18.13 17.89 17.72 0.14 18.58 17.39 16.91 16.64 16.47 16.36

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.14

We used our ke of 10.11% that we calculated with CAPM and used Family Dollar’s observed share price of $23.24. Using our FDO forecasted earnings and dividends for the next ten years allowed us to derive their total book value of equity. Then, we needed to find the “normal” earnings, or benchmark earnings,

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by taking the previous year’s book value of equity multiplied by ke of 10.11%. The next step is to find residual income values which is found by subtracting actual earnings by the normal, or benchmark, earnings. Then, we found FDO’s present value factor for each of its forecasted years and brought them back to the present. We then found the sum of all of the total present value of the annual residual income. The year by year annual residual income figures will later come in handy as check figures when running the Abnormal Earnings Growth model. The continuing terminal value of the perpetuity and the present value of the terminal value Perpetuity are found next in this model. Once computed, we added Family Dollar’s total present values of residual income, the present value of terminal value perpetuity and the initial book value of equity and divided the sum by current shares outstanding to find Family Dollar’s estimated price per share. According to Yahoo! Finance, Family Dollar’s share price for November of 2007 was $23.24. A sensitivity analysis table was constructed by changing our growth rate and ke in the model and recording the yielded values. This model is not as sensitive to errors as the previous intrinsic models. Greatly varying the cost of capital or the growth has little effect to the implied share price. The Residual Income Model helps us to understand the value of future excess income after all of the liabilities or debt obligations of the company have been paid off. This model implies that Family Dollar is fairly valued.

Long Run Return on Equity Residual Income Model

The Long Run Return on Equity Residual model, or the Residual Income Perpetuity model, is another intrinsic valuation model that is derived from the residual income model. This model uses a perpetuity equation which was used when we ran the residual income model. The main components we need for this valuation model is the book value of equity, the cost of equity, the long run return on equity, and the growth

rate. The residual income perpetuity model measures value through the perpetuity 114

itself. To find Family Dollar’s book value of equity, we took the 2006 book value of equity that is recorded on the balance sheet. We then divided the figure by the shares outstanding to obtain a book value of equity per share of $8.602. The cost of equity was found above in the section labeled cost of equity. We computed Family Dollar’s cost of equity to be 10.11%. Family Dollar’s long run return on equity came out to 13.66%. Also, as noted throughout this whole valuation, Family Dollar’s observed share price is $23.24. The sensitivity analysis tables for long run residual income perpetuity model follow.

g ke 0.12 0.14 0.16 0.18 0.2 0.06 N/A 0.37 2.01 3.11 3.9 0.08 N/A 0.49 2.52 3.73 4.54 0.1011 N/A 0.75 3.42 4.73 5.51 0.13 14.28 2.92 6.71 7.47 7.79 0.15 4.76 N/A 20.13 12.44 10.91

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

ROE ke 0.09 0.12 0.1366 0.16 0.18 0.06 12.9 17.2 19.58 22.94 25.81 0.08 9.68 12.9 14.69 17.2 19.36 0.1011 7.66 10.21 11.62 13.61 15.32 0.13 5.96 7.94 9.04 10.59 11.91 0.15 5.16 6.88 7.84 9.18 10.32

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

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g ROE 0.12 0.14 0.16 0.18 0.2 0.09 13.65 11.06 10.22 9.81 9.57 0.12 4.42 5.84 6.54 6.96 0.1366 N/A 0.75 3.42 4.73 5.51 0.16 N/A N/A 2.18 3.48 0.18 N/A N/A N/A 1.74

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

Running a sensitivity analysis in a similar fashion as the previous analysis’, the residual income perpetuity model labels FDO’s stock as overvalued. We find this model to have little explanatory power because of the many assumptions and speculations that are imbedded in the calculated the perpetuity. We are not going to include this overvalued share price result in our overall buy, sell or hold recommendation.

Abnormal Earnings Growth Model

The Abnormal Earnings Growth model calculates a firm’s intrinsic value from a firm’s future earnings along with cumulative dividend earnings based on a dividend reinvestment plan. The AEG model uses a benchmark earnings figure each year in order to determine whether value is created or destroyed by the firm from year to year. Abnormal earnings growth figures are discounted back to year one as versus year zero like the other models. AEG model is backed by financial theory by directly linking this model to accounting figures. This can be seen by observing that the abnormal earnings growth from year to year equal to the change in residual income from year to year.

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Sensitivity Analysis g 0-0.1-0.2-0.3-0.4 0.08 50.69 39.50 36.30 34.79 33.91 Ke 0.09 37.24 30.84 28.85 27.88 27.30 0.1011 27.20 23.83 22.69 22.13 21.79 0.12 16.78 15.87 15.53 15.35 15.24 0.14 10.57 10.66 10.70 10.72 10.73

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

The first step for using the AEG model is to determine cumulative dividend earnings. Our cumulative dividend earnings were equal to our forecasted earnings plus D.R.I.P income. D.R.I.P. income was found by multiplying the previous year’s dividends by our %10.11 cost of equity. Next, we figured our normal earnings benchmark by multiplying the previous year’s earnings by Ke plus 1. Subtracting our benchmark earnings for the year from that year’s cumulative dividends earnings equaled abnormal earnings growth for the particular year. The annual AEG for each year from 2008 to 2016 were discounted back to year 1’s dollars using Ke and the present value formula. Assuming a zero growth rate when calculating the perpetuity, we discounted that figure back to 2008 dollars as well. Once we had the sum of our present values of AEG, we added that figure along with the present value of the perpetuity to 2007 forecasted earnings. The calculated total of $356,601 was divided by the capitalization rate, equal to Ke, to figure the intrinsic value of FDO in total dollars. We divided our figured value by shares outstanding of 147,403 which delivered us an end of 2006 intrinsic value per share of $25.11. Growing $25.22 by 10 months yielded us the time consistent implied share price of $27.21. Our sensitivity analysis helped us to determine that FDO is fairly valued according to the Abnormal Earnings Growth model using our estimated Ke and any growth rate from 0 to -.4. Negative growth rates are used because the 117

model is eventually showing a convergence to zero. We proved the consistency of our valuation models by showing that our AEG per year was equal to the change in residual income per year.

2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual Change in R.I. 8771.40 9685.38 10694.59 11808.97 13039.47 14398.18 15898.47 17555.09 19384.33 Abnormal Earnings Growth 8771.40 9685.38 10694.59 11808.97 13039.47 14398.18 15898.47 17555.09 19384.33

Overall Conclusion

All in all, we chose to consider only the residual income and AEG models when concluding an investment recommendation. AEG and Residual Income models are most accurate because they are linked to earnings, dividends and book value of liabilities. These items were more easily forecasted than cash flows. We chose to ignore the results of the long run residual income perpetuity model because of extreme speculation in determining perpetuity. Because forecasted cash flows are more prone to error, we assumed the discounted free cash flow model along with the discounted dividend model were less meaningful for our intended purpose. According to our intrinsic valuations we would say that Family Dollar Inc is an undervalued firm.

Credit Analysis

A credit analysis is performed in order to ultimately determine the likeliness of a firm entering into a financial disaster and not being able to meet debt obligations. A firm’s credit worthiness is of interest to current and potential debt holders of the firm. Generally speaking, cost of debt and credit worthiness should have an inverse relationship because of the demand of greater reward for taking on greater risk.

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The Altman Z – score model was the model that we used to predict the degree of bankruptcy risk of Family Dollar. Altman Z – score is equal to the sum of five weighted financial ratios. “The model predicts bankruptcy when Z<1.81. The range between 1.81 and 2.67 is labeled the gray area.”(Palepu and Healy 2008) The formula is as follows:

Z = 1.2(net working capital/total assets) + 1.4(retained earnings/total assets) + 3.3(EBIT/total assets) + .6(market cap/book value of total liabilities) + 1.0(sales/total assets)

2002 2003 2004 2005 2006 Z-Score 9.202 10.45 5 7.235 6.099 5.773

FAMILY DOLLAR

Family Dollar’s debt holders should not be too worried about Family dollar not fulfilling their debt obligations seeing as the Z – scores are well over 1.81. The score has been on the decline since 2003, which we found to be mostly an effect of a shrinking market value of equity.

Revised Z-Score

Family Dollar 2002 2003 2004 2005 2006 Z-Score 9.202 10.455 7.235 6.099 5.773 Revised Z-Score 5.753 6.321 4.689 3.986 3.893

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The effect of capitalization of operating leases was reflected in the z-score as a lower score for the past 5 years. The increase in bankruptcy possibility is mainly a result of an increase in total assets and total liabilities. With a Z-Score well over 2.67, Family Dollar is still perceived as a very credit worthy firm.

Analyst Recommendation After a comprehensive analysis of the Family Dollar Inc. and the industry we have concluded that FDO is currently and undervalued stock and recommend its purchase. This decision is a result of an extensive industry, accounting, financial, and valuation analyses. FDO operates in a highly saturated industry in which their KSF’s and cost leadership strategy allow them to continue to grow. They have properly linked their KAP’s with their key success factors and keep disclosure and quality of financial statements at or above industry norms. The only potential foreseeable problem for FDO is the capitalization of their operating leases, but this is normal for the rest of the industry and of little concern as long as the company continues to grow. Both profitability and capital structure ratios for the company are also inline or outpacing the same ratios of competing firms. Finally, the intrinsic valuation models that can be heavily weighed upon (Residual Income, and Abnormal Earnings Growth) both show FDO to be undervalued as of November 1, 2007.

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Appendices

2002 Capitalization of Operating Leases, Discount Rate 5.33% Year T Commitment PV Factor Present Value 2003 1 $169,240 0.949397133 $160,675.97 2004 2 $146,652 0.901354916 $132,185.50 2005 3 $118,929 0.855743773 $101,772.75 2006 4 $87,770 0.812440684 $71,307.92 2007 5 $54,982 0.771328856 $42,409.20 2008 6 $51,375 0.732297405 $37,621.41 2009 7 $51,375 0.695241056 $35,717.66 Total PV of Operating Lease Expenses: $581,690

2003 Capitalization of Operating Leases, Discount Rate 5.33% Year T Commitment PV Factor Present Value 2004 1 $190,840 0.949397133 $181,182.95 2005 2 $167,434 0.901354916 $150,917.46 2006 3 $136,444 0.855743773 $116,761.10 2007 4 $102,997 0.812440684 $83,678.95 2008 5 $67,204 0.771328856 $51,836.38 2009 6 $65,823 0.732297405 $48,202.01 2010 7 $65,823 0.695241056 $45,762.85 Total PV of Operating Lease Expenses: $678,342

121

2004 Capitalization of Operating Leases, Discount Rate 5.33%

2005 Capitalization of Operating Leases, Discount Rate 5.33%

2006 Capitalization of Operating Leases, Discount Rate 5.33%

122

Family Dollar’s Forecasted Income Statement

Actual Financial Statements Forecast Financial Statements (in thousands) 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Gross Profit $1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306 $2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217

Operating profit $298,422 $341,621 $389,725 $403,362 $338,810 $317,305 7.54% $532,407 $587,884 $649,142 $716,782 $791,471 $873,943 $965,007 $1,065,561 $1,176,593 $1,299,193

Interest income $0 $0 $0 $3,300 $3,985 $6,934 Interest expense $0 $0 $0 $0 $0 $13,095

Income before income taxes $298,422 $341,621 $389,725 $406,662 $342,795 $311,144

Income taxes $108,917 $124,692 $142,250 $148,758 $125,286 $116,033

Net income $189,505 $216,929 $247,475 $257,904 $217,509 $195,111 4.54% $320,574 $353,978 $390,863 $431,591 $476,562 $526,220 $581,052 $641,598 $708,452 $782,273

123

Forecasted Income Statement with Capital Lease Corrections

Income Statement (in thousands, except per share amounts) with lease adjustments 0.33534367 Actual Financial Statements Forecast Financial Statements 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sales Growth 14% 14% 11% 10% 10% Years ended 2001 31-Aug-02 30-Aug-03 28-Aug-04 27-Aug-05 26-Aug-06 Net sales $3,665,362 $4,162,652 $4,750,171 $5,281,888 $5,824,808 $6,394,772 10.42% $7,061,107 $7,796,875 $8,609,309 $9,506,399 $10,496,966 $11,590,750 $12,798,506 $14,132,110 $15,604,676 $17,230,683 Cost of sales $2,439,261 $2,766,733 $3,145,788 $3,496,278 $3,908,569 $4,276,466 66.57% $4,700,579 $5,190,379 $5,731,217 $6,328,410 $6,987,830 $7,715,962 $8,519,965 $9,407,746 $10,388,033 $11,470,466

Gross Profit $1,226,101 $1,395,919 $1,604,383 $1,785,610 $1,916,239 $2,118,306 $2,360,528 $2,606,495 $2,878,092 $3,177,989 $3,509,136 $3,874,788 $4,278,540 $4,724,364 $5,216,643 $5,760,217 Reversal of Operating Lease Rent $158,949 $185,372 $212,866 $242,910 $279,232 $298,362 Less: Capital Lease Depreciation Expense $133,241 $154,368 $176,710 $199,193 $228,046 $243,713 Selling, general and administrative $927,679 $1,054,298 $1,214,658 $1,382,248 $1,577,429 $1,756,001 25.89% $1,828,121 $2,018,611 $2,228,950 $2,461,207 $2,717,664 $3,000,845 $3,313,533 $3,658,803 $4,040,051 $4,461,024 Litigation charge (Note 8) $0 $0 $0 $0 $0 $45,000 Cost of sales and operating expenses $3,366,940 $4,160,771 $4,750,022 $5,320,629 $5,993,276 $6,619,542 $6,528,700 $7,208,990 $7,960,167 $8,789,616 $9,705,495 $10,716,807 $11,833,498 $13,066,549 $14,428,083 $15,931,490

Operating profit $324,130 $372,625 $425,881 $447,079 $389,996 $371,954 7.54% $532,407 $587,884 $649,142 $716,782 $791,471 $873,943 $965,007 $1,065,561 $1,176,593 $1,299,193

Interest income $0 $0 $0 $3,300 $3,985 $6,934 Implied Interest Expense on lease payment $25,708 $31,004 $36,156 $43,717 $51,186 $54,649 Interest expense $0 $0 $0 $0 $0 -$13,095

Income before income taxes $298,422 $341,621 $389,725 $406,662 $342,795 $311,144 tax rate 36% 37% 37% 37% 37% 37% Income taxes $108,917 $124,692 $142,250 $148,758 $125,286 $116,033

Net income $189,505 $216,929 $247,475 $257,904 $217,509 $195,111 4.54% $320,574 $353,978 $390,863 $431,591 $476,562 $526,220 $581,052 $641,598 $708,452 $782,273

Net income per common share basic $1 $1.26 $1.44 $1.51 $1.30 $1.26 Average shares basic $171,568 $172,800 $172,346 $170,770 $166,791 $154,967 Net income per common share diluted $1 $1.25 $1.43 $1.50 $1.30 $1.26 Average shares diluted $172,774 $174,049 $173,354 $171,624 $167,092 $155,124

124

Family Dollar’s Income Statement (Common Size)

Year End 2001 2002 2003 2004 2005 2006 Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of Sales 66.55% 66.47% 66.22% 66.19% 67.10% 66.87% Gross Profit on Sales 33.45% 33.53% 33.78% 33.81% 32.90% 33.13% S,G, and A Expenses 25.31% 25.33% 25.57% 26.17% 27.08% 28.16% Operating Income 8.14% 8.21% 8.20% 7.64% 5.82% 4.96% Interest Income 0.00% 0.00% 0.00% 0.06% 0.07% 0.11% Interest Expense 0.00% 0.00% 0.00% 0.00% 0.00% 0.20% Income Before Taxes 8.14% 8.21% 8.20% 7.70% 5.89% 4.87% Income Tax 2.97% 3.00% 2.99% 2.82% 2.15% 1.81% Net Income 5.17% 5.21% 5.21% 4.88% 3.73% 3.05%

125

Family Dollar’s Forecasted Balance Sheet

Total Assets $1,399,745 $1,754,619 $1,985,695 $2,224,361 $2,409,501 $2,523,029 2.45 $2,882,085 $3,182,398 $3,514,004 $3,880,163 $4,284,476 $4,730,918 $5,223,880 $5,768,208 $6,369,255 $7,032,932

Non-Current Liabilities (forecast plug) $50,436 $68,891 $79,395 $86,694 $86,824 $328,525 $680,705 $633,905 $582,228 $525,167 $462,159 $392,586 $315,764 $230,937 $137,271 $33,845

TOTAL LIABILITIES Forecast plug $440,730 $599,671 $674,726 $887,279 $981,435 $1,314,636 $1,430,047 $1,461,328 $1,495,869 $1,534,009 $1,576,123 $1,622,625 $1,673,973 $1,730,671 $1,793,277 $1,862,407

Shareholders equity: (Notes 9, 10 and 11) Preferred stock, $1 par; authorized and unissued 500,000 shares

126

Family Dollar’s Balance Sheet (Common Size)

Actual Financial Statements 2001 2002 2003 2004 2005 2006 (in thousands, except per share and share amounts) Assets Current assets: Cash and cash equivalents 1.16% 11.70% 10.98% 4.62% 5.59% 4.24% Investment securities (Note 2) 3.97% 1.10% 4.48% Merchandise inventories 38.34% 32.81% 32.07% 32.19% 32.37% 29.25% Deferred income taxes (Note 6) 2.34% 2.14% 2.32% 2.76% 2.98% 3.76% Income tax refund receivable 0.26% 0.28% 0.00% 0.04% 0.00% 0.07% Prepayments and other current assets 0.80% 0.54% 1.26% 0.56% 0.74% 0.81% Total current assets 42.89% 45.19% 43.41% 42.38% 40.20% 39.99%

Property and equipment, net (Note 3) 30.86% 29.35% 30.48% 30.17% 30.49% 30.37% Other assets 0.62% 0.56% 0.64% 0.51% 0.81% 0.75% Non-Current Assets 57.11% 54.81% 56.59% 57.62% 59.80% 60.01% Total Assets 100% 100% 100% 100% 100% 100% Liabilities and Shareholders Equity Current liabilities: Accounts payable 14% 16.31% 15.08% 17.55% 17.06% 15.68% Accrued liabilities (Note 5) 1% 6.40% 7.24% 8.74% 9.36% 12.11% Income taxes payable 0% 0.00% 0.03% 0.00% 0.13% 0.00% Total current liabilities 20.74% 22.72% 22.35% 26.30% 26.55% 27.79% Long-term debt (Note 4) 7.05% Deferred income taxes (Note 6) 3% 2.95% 2.98% 2.85% 2.58% 2.21% Non-Current Liabilities 28% 27.85% 28.44% 29.79% 31.07% 38.15% TOTAL LIABILITIES 49% 51% 51% 56% 58% 66%

Shareholders equity: (Notes 9, 10 and 11) Preferred stock, $1 par; authorized and unissued 500,000 shares Common stock, $.10 par; authorized 600,000,000 1% 0.80% 0.70% 0.62% 0.56% 0.50% shares; issued 178,559,411 shares at August 26, 2006, and 188,871,738 shares at August 27, 2005, and outstanding 150,210,484 shares at

August 26, 2006, and 165,262,513 shares at August 27, 2005 Capital in excess of par 2% 2.71% 3.28% 3.51% 3.97% 3.97% Retained earnings 50% 47.85% 49.38% 49.23% 49.11% 43.58% Total 53% 51.36% 53.37% 53.36% 53.64% 48.05% Less: common stock held in treasury, at 2% 1.92% 4.16% 9.44% 11.26% 14.00% cost (28,348,927 shares at August 26, 2006, and 23,609,225 shares at August 27, 2005)

Total shareholders equity 51% 49.43% 49.21% 43.92% 42.38% 34.06%

Total Liabilities and Shareholders Equity 100% 100.00% 100.00% 100.00% 100.00% 100.00%

127

Forecasted Balance Sheet with Capital Lease Adjustments

Balance Sheet With lease adjustments

Actual Financial Statements Forecast Financial Statements 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (in thousands, except per share and share amounts) Assets Current assets: Cash and cash equivalents $21,753 $220,265 $206,731 $87,023 $105,175 $79,727 Investment securities (Note 2) $0 $0 $0 $120,840 $33,530 $136,505 Merchandise inventories $721,560 $766,631 $854,370 $980,124 $1,090,791 $1,037,859 3.76 $1,250,154 $1,380,420 $1,524,260 $1,683,088 $1,858,465 $2,052,118 $2,265,948 $2,502,060 $2,762,775 $3,050,656 Deferred income taxes (Note 6) $43,985 $49,941 $61,769 $84,084 $100,493 $133,468 Income tax refund receivable $4,936 $6,469 $0 $1,304 $0 $2,397 Prepayments and other current assets $15,031 $12,553 $33,622 $16,937 $24,779 $28,892 Total current assets $807,265 $1,055,859 $1,156,492 $1,290,312 $1,354,768 $1,418,848 42.34% $1,660,929 $1,833,998 $2,025,101 $2,236,116 $2,469,120 $2,726,402 $3,010,493 $3,324,186 $3,670,567 $4,053,040

Property and equipment, net (Note 3) $580,879 $685,617 $812,123 $918,449 $1,027,475 $1,077,608 Other assets $11,601 $13,143 $17,080 $15,600 $27,258 $26,573 Capital Lease Rights $482,321 $581,690 $678,342 $820,212 $960,332 $1,025,306 Non-Current Assets $1,074,801 $1,280,450 $1,507,545 $1,754,261 $2,015,065 $2,129,487 57.66% $2,261,908 $2,497,599 $2,757,849 $3,045,216 $3,362,528 $3,712,903 $4,099,788 $4,526,986 $4,998,698 $5,519,562

Total Assets $1,882,066 $2,336,309 $2,664,037 $3,044,573 $3,369,833 $3,548,335 1.80 $3,922,837 $4,331,597 $4,782,949 $5,281,333 $5,831,648 $6,439,305 $7,110,281 $7,851,172 $8,669,264 $9,572,602

Liabilities and Shareholders Equity Current liabilities: Accounts payable $264,965 $381,164 $401,799 $534,405 $574,831 $556,531 Accrued liabilities (Note 5) $12,329 $149,616 $192,861 $266,180 $315,508 $429,580 Income taxes payable $0 $0 $671 $0 $4,272 $0 Total current liabilities $390,294 $530,780 $595,331 $800,585 $894,611 $986,111 26% $1,019,938 $1,126,215 $1,243,567 $1,373,147 $1,516,228 $1,674,219 $1,848,673 $2,041,305 $2,254,009 $2,488,876 Long-term debt (Note 4) $0 $0 $0 $0 $0 $250,000 $1,275,306 Deferred income taxes (Note 6) $50,436 $68,891 $79,395 $86,694 $86,824 $78,525 Capital Lease Long-Term Debt $482,321 $581,690 $678,342 $820,212 $960,332 $1,025,306

Non-Current Liabilities (forecast plug) $532,757 $650,581 $757,737 $906,906 $1,047,156 $1,353,831 $1,450,862 $1,484,312 $1,521,248 $1,562,032 $1,607,066 $1,656,793 $1,711,701 $1,772,330 $1,839,277 $1,913,200

TOTAL LIABILITIES Forecast plug $923,051 $1,181,361 $1,353,068 $1,707,491 $1,941,767 $2,339,942 $2,470,800 $2,610,528 $2,764,815 $2,935,179 $3,123,295 $3,331,012 $3,560,374 $3,813,635 $4,093,286 $4,402,077

Shareholders equity: (Notes 9, 10 and 11) Preferred stock, $1 par; authorized and unissued 500,000 shares

Total Liabilities and Shareholders Equity $1,882,066 $2,336,309 $2,664,037 $3,044,573 $3,369,833 $3,548,335 $3,922,837 $4,331,597 $4,782,949 $5,281,333 $5,831,648 $6,439,305 $7,110,281 $7,851,172 $8,669,264 $9,572,602

128

Family Dollar’s Statement of Cash Flows

129

Family Dollar’s Statement of Cash Flows (Common Size)

2001 2002 2003 2004 2005 2006 Cash flows from operating activities: Net income 114.22% 52.56% 82.00% 68.50% 72.66% 43.26% Adjustments to reconcile net income to 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% net cash provided by operating activities: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Depreciation and amortization 40.80% 18.66% 29.26% 27.10% 38.33% 29.85% Deferred income taxes 14.64% 3.03% -0.44% -0.40% -5.44% -9.15% Stock-based compensation expense, including 0.00% 2.45% 2.26% 1.19% 1.24% 1.76% tax benefits 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Loss on disposition of property and equipment -0.49% 0.55% 1.29% 1.15% 1.10% 1.24% Changes in operating assets and liabilities: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Merchandise inventories -46.38% -10.92% -29.07% -33.40% -36.97% 11.74% Income tax refund receivable -2.98% -0.37% 2.14% -0.35% 0.44% -0.53% Prepayments and other current assets -2.47% 0.60% -6.98% 4.43% -2.62% -0.91% Other assets -3.70% -0.37% -1.30% 0.39% -3.89% 0.44% Accounts payable and accrued liabilities -9.32% 33.81% 20.62% 32.30% 33.73% 23.25% Income taxes payable -4.33% 0.00% 0.22% -0.18% 1.43% -0.95% CASH FLOW FROM OPERATIONS 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

130

Forecasted Statement of Cash Flow with Capital Lease Adjustments

Cash Flows With Lease Adjustments Actual Financial Statements Forecast Financial Statements 2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Cash flows from operating activities: Net income $189,505 $216,929 $247,475 $257,904 $217,509 $195,111 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 67,685 $77,015 $88,315 102,010 114,733 134,637 31.13% $153,486 $174,974 $199,471 $227,397 $259,232 $295,525 $336,898 $384,064 $437,833 $499,129 Deferred income taxes 24,281 $12,499 ($1,325) (1,496) (16,279) (41,274) Stock-based compensation expense, including 0 $10,123 $6,815 4,476 3,700 7,931 tax benefits Loss on disposition of property and equipment (809) $2,287 $3,905 4,311 3,306 5,603 Changes in operating assets and liabilities: Merchandise inventories (76,946) ($45,071) ($87,739) (125,754) (110,667) 52,932 Income tax refund receivable (4,936) ($1,533) $6,469 (1,304) 1,304 (2,397) Prepayments and other current assets (4,094) $2,478 ($21,069) 16,685 (7,842) (4,113) Other assets (6,144) ($1,542) ($3,937) 1,480 (11,658) 1,968 Accounts payable and accrued liabilities (15,455) $139,541 $62,233 121,608 100,974 104,867 Income taxes payable (7,177) $0 $671 (671) 4,272 (4,272) CASH FLOW FROM OPERATIONS 165,910 $412,726 $301,813 376,477 299,352 450,993$ 493,049 $ 562,076 $ 640,767 $ 730,474 $ 832,740 $ 949,324 $ 1,082,229 $ 1,233,741 $ 1,406,465 $ 1,603,370 Cash Flow From Investing (160,170) ($184,040) ($218,727) ($216,585) ($139,755) ($293,348) ($132,421) ($235,691) ($260,250) ($287,368) ($317,312) ($350,375) ($386,885) ($427,198) ($471,712) ($520,864) Cash Flow From Financing (27,545) ($30,147) ($96,621) ($216,408) ($141,445) ($236,909) -132 -236 -260 -287 -317 -350 -387 -427 -472 -521

131

3 Month Time Period Adjusted (months) R² Est. Beta ke 72 10.46% 0.75 10.12% 60 6.76% 0.84 10.84% 48 5.13% 0.98 11.94% 36 4.48% 1.00 12.11% 24 7.86% 1.26 14.13% 1 Year Time Period Adjusted (months) R² Est. Beta ke 72 10.50% 0.75 10.12% 60 6.84% 0.84 10.86% 48 5.24% 0.99 11.99% 36 4.56% 1.01 12.15% 24 7.93% 1.26 14.15% 2 Year Time Period Adjusted (months) R² Est. Beta ke 72 10.52% 0.75 10.11% 60 6.93% 0.85 10.89% 48 5.41% 1.00 12.07% 36 4.67% 1.01 12.19% 24 7.97% 1.26 14.15% 5 Year Time Period Adjusted (months) R² Est. Beta ke 72 10.53% 0.75 10.11% 60 7.01% 0.85 10.93% 48 5.69% 1.01 12.22% 36 4.75% 1.02 12.24% 24 8.06% 1.26 14.19% 7 Year Time Period Adjusted (months) R² Est. Beta ke 72 10.52% 0.75 10.10% 60 7.02% 0.85 10.94% 48 5.78% 1.02 12.26% 36 4.77% 1.02 12.25% 24 8.08% 1.27 14.20%

132

3 Month Time Period Adjusted Est. (months) R² Beta ke Published Beta 1.01 72 10.46% 0.75 10.12% Risk-Free Rate .0420 60 6.76% 0.84 10.84% 48 5.13% 0.98 11.94% 36 4.48% 1.00 12.11% 24 7.86% 1.26 14.13%

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.342350394 R Square 0.117203793 Adjusted R Square 0.104592418 St an d ar d Er r o r 0.071967368 Observat ions 72

ANOVA df SS MS F Significance F Regression 1 0.048133837 0.048133837 9.293498782 0.003244149 Residual 70 0.362551144 0.005179302 Total 71 0.410684981

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.000182628 0.008527919 -0.021415306 0.982975291 -0.017191025 0.016825769 -0.017191025 0.016825769 X Variable 1 0.748887493 0.245655761 3.048524033 0.003244149 0.258942532 1.238832454 0.258942532 1.238832454

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.288754523 R Square 0.083379174 Adjusted R Square 0.067575367 St an d ar d Er r o r 0.073583182 Observat ions 60

ANOVA df SS MS F Significance F Regression 1 0.028566235 0.028566235 5.2758916 0.025251804 Residual 58 0.314040115 0.005414485 Total 59 0.34260635

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004847637 0.009864026 -0.491446135 0.62496562 -0.024592631 0.014897356 -0.024592631 0.014897356 X Variable 1 0.839891054 0.365657953 2.296930909 0.025251804 0.107947142 1.571834966 0.107947142 1.571834966

133

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.267416638 R Square 0.071511658 Adjusted R Square 0.051327129 St an d ar d Er r o r 0.076329308 Observat ions 48

ANOVA df SS MS F Significance F Regression 1 0.020641482 0.020641482 3.542894535 0.066135672 Residual 46 0.268003513 0.005826163 Total 47 0.288644995

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.011814285 0.011389479 -1.037298118 0.305019115 -0.034740118 0.011111547 -0.034740118 0.011111547 X Variable 1 0.980187752 0.520751056 1.882257829 0.066135672 -0.06802974 2.028405245 -0.06802974 2.028405245

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.268416537 R Square 0.072047438 Adjusted R Square 0.044754715 Standard Error 0.078860078 Obser vat ions 36

ANOVA df SS MS F Significance F Regression 1 0.016416709 0.016416709 2.639803989 0.113452137 Residual 34 0.211443007 0.006218912 Tot al 35 0.227859715

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004485035 0.013589072 -0.33004721 0.743389321 -0.032101352 0.023131282 -0.032101352 0.023131282 X Variable 1 1.000869224 0.616015294 1.624747362 0.113452137 -0.251024468 2.252762916 -0.251024468 2.252762916

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.344423914 R Square 0.118627832 Adjusted R Square 0.078565461 Standard Error 0.07169887 Obser vat ions 24

ANOVA df SS MS F Significance F Regression 1 0.0152221 0.0152221 2.961078657 0.099327031 Residual 22 0.113096014 0.005140728 Total 23 0.128318114

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002521106 0.015424481 0.163448366 0.871657632 -0.029467309 0.034509521 -0.029467309 0.034509521 X Variable 1 1.257190596 0.730594085 1.720778503 0.099327031 -0.257968793 2.772349985 -0.257968793 2.772349985

134

1 Year Time Period Adjusted Est. (months) R² Beta ke Published Beta 1.01 72 10.50% 0.75 10.12% Risk-Free Rate .0420 60 6.84% 0.84 10.86% 48 5.24% 0.99 11.99% 36 4.56% 1.01 12.15% 24 7.93% 1.26 14.15%

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.342951447 R Square 0.117615695 Adjusted R Square 0.105010205 St an d ar d Er r o r 0.071950576 Observat ions 72

ANOVA df SS MS F Significance F Regression 1 0.048303 0.048303 9.330513505 0.003186913 Residual 70 0.362381982 0.005176885 Total 71 0.410684981

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -1.14701E-05 0.008520117 -0.001346238 0.998929687 -0.017004307 0.016981367 -0.017004307 0.016981367 X Variable 1 0.749074948 0.24522938 3.054588926 0.003186913 0.259980378 1.238169517 0.259980378 1.238169517

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.290184328 R Square 0.084206944 Adjusted R Square 0.068417409 Standard Error 0.07354995 Obser vat ions 60

ANOVA df SS MS F Significance F Regression 1 0.028849834 0.028849834 5.333085596 0.024505536 Residual 58 0.313756516 0.005409595 Total 59 0.34260635

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004694585 0.009838495 -0.477165 0.635037769 -0.024388472 0.014999301 -0.024388472 0.014999301 X Variable 1 0.843031122 0.365051663 2.309347439 0.024505536 0.112300833 1.573761412 0.112300833 1.573761412

135

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.269366833 R Square 0.072558491 Adjusted R Square 0.052396719 St an d ar d Er r o r 0.076286267 Observat ions 48

ANOVA df SS MS F Significance F Regression 1 0.020943645 0.020943645 3.598815171 0.064109163 Residual 46 0.26770135 0.005819595 Total 47 0.288644995

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.011624537 0.011352995 -1.023918071 0.311228661 -0.034476931 0.011227857 -0.034476931 0.011227857 X Variable 1 0.986199943 0.519858563 1.897054341 0.064109163 -0.060221054 2.03262094 -0.060221054 2.03262094

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.270003366 R Square 0.072901817 Adjusted R Square 0.045634224 Standard Error 0.078823766 Obser vat ions 36

ANOVA df SS MS F Significance F Regression 1 0.016611387 0.016611387 2.6735699 0.111253082 Residual 34 0.211248328 0.006213186 Tot al 35 0.227859715

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.00434233 0.013555893 -0.320327849 0.750680235 -0.03189122 0.02320656 -0.03189122 0.02320656 X Variable 1 1.005774158 0.615112711 1.635105471 0.111253082 -0.244285264 2.255833581 -0.244285264 2.255833581

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.345454755 R Square 0.119338988 Adjusted R Square 0.079308942 Standard Error 0.071669938 Obser vat ions 24

ANOVA df SS MS F Significance F Regression 1 0.015313354 0.015313354 2.981235342 0.098252418 Residual 22 0.11300476 0.00513658 Total 23 0.128318114

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002603413 0.015398732 0.169066727 0.867289009 -0.029331603 0.034538429 -0.029331603 0.034538429 X Variable 1 1.25993785 0.729711167 1.72662542 0.098252418 -0.253390479 2.773266178 -0.253390479 2.773266178

136

2 Year Time Period Adjusted Est. (months) R² Beta ke Published Beta 1.01 72 10.52% 0.75 10.11% Risk-Free Rate .0420 60 6.93% 0.85 10.89% 48 5.41% 1.00 12.07% 36 4.67% 1.01 12.19% 24 7.97% 1.26 14.15%

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.343264596 R Square 0.117830583 Adjusted R Square 0.105228162 Standard Error 0.071941815 Obser vat ions 72

ANOVA df SS MS F Si g n i f i ca n ce F Regression 1 0.048391251 0.048391251 9.349837596 0.003157452 Residual 70 0.362293731 0.005175625 Total 71 0.410684981

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000166024 0.008513542 0.019501171 0.984496783 -0.0168137 0.017145748 -0.0168137 0.017145748 X Variable 1 0.748271382 0.244713034 3.057750414 0.003157452 0.260206631 1.236336134 0.260206631 1.236336134

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.291736457 R Square 0.08511016 Adjusted R Square 0.069336198 St an d ar d Er r o r 0.073513671 Observat ions 60

ANOVA df SS MS F Significance F Regression 1 0.029159281 0.029159281 5.395610589 0.023716574 Residual 58 0.313447068 0.00540426 Total 59 0.34260635

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004585286 0.00981791 -0.467032843 0.642226155 -0.024237968 0.015067395 -0.024237968 0.015067395 X Variable 1 0.847133396 0.364696423 2.322845365 0.023716574 0.117114195 1.577152596 0.117114195 1.577152596

137

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.272466245 R Square 0.074237855 Adjusted R Square 0.054112591 St an d ar d Er r o r 0.076217168 Observat ions 48

ANOVA df SS MS F Significance F Regression 1 0.021428385 0.021428385 3.6887891 0.060990766 Residual 46 0.26721661 0.005809057 Total 47 0.288644995

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.011550665 0.011325888 -1.019846282 0.313135315 -0.034348495 0.011247165 -0.034348495 0.011247165 X Variable 1 0.99654207 0.518864221 1.920622061 0.060990766 -0.047877421 2.04096156 -0.047877421 2.04096156

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.271883196 R Square 0.073920472 Adjusted R Square 0.046682839 St an d ar d Er r o r 0.07878045 Observat ions 36

ANOVA df SS MS F Significance F Regression 1 0.016843498 0.016843498 2.713909533 0.10868973 Residual 34 0.211016218 0.006206359 Tot al 35 0.227859715

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004352053 0.013544214 -0.321321914 0.749933462 -0.031877206 0.023173101 -0.031877206 0.023173101 X Variable 1 1.01135428 0.613911309 1.647394772 0.10868973 -0.236263599 2.258972159 -0.236263599 2.258972159

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.345988185 R Square 0.119707824 Adjusted R Square 0.079694544 Standard Error 0.071654928 Obser vat ions 24

ANOVA df SS MS F Significance F Regression 1 0.015360682 0.015360682 2.991702314 0.097699737 Residual 22 0.112957431 0.005134429 Total 23 0.128318114

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002485745 0.015414535 0.161259813 0.873360508 -0.029482044 0.034453534 -0.029482044 0.034453534 X Variable 1 1.25973938 0.728318794 1.729653813 0.097699737 -0.250701345 2.770180105 -0.250701345 2.770180105

5 Year

138

Time Period Adjusted Est. (months) R² Beta ke 72 10.53% 0.75 10.11% 60 7.01% 0.85 10.93% Published Beta 1.01 48 5.69% 1.01 12.22% Risk-Free Rate .0420 36 4.75% 1.02 12.24% 24 8.06% 1.26 14.19%

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.343411581 R Square 0.117931514 Adjusted R Square 0.105330536 Standard Error 0.071937699 Obser vat ions 72

ANOVA df SS MS F Significance F Regression 1 0.048432702 0.048432702 9.358917282 0.003143707 Residual 70 0.362252279 0.005175033 Total 71 0.410684981

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000578759 0.008501851 0.06807442 0.945920471 -0.016377647 0.017535165 -0.016377647 0.017535165 X Variable 1 0.747883101 0.244467379 3.059234754 0.003143707 0.260308295 1.235457907 0.260308295 1.235457907

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.293049875 R Square 0.085878229 Adjusted R Square 0.070117509 St an d ar d Er r o r 0.073482806 Observat ions 60

ANOVA df SS MS F Significance F Regression 1 0.029422427 0.029422427 5.448877231 0.023065815 Residual 58 0.313183923 0.005399723 Total 59 0.34260635

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004228187 0.00977302 -0.432638693 0.66688176 -0.023791012 0.015334639 -0.023791012 0.015334639 X Variable 1 0.852179401 0.365071156 2.334283023 0.023065815 0.121410091 1.58294871 0.121410091 1.58294871

139

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.277461107 R Square 0.076984666 Adjusted R Square 0.056919115 Standard Error 0.076104013 Obser vat ions 48

ANOVA df SS MS F Significance F Regression 1 0.022221239 0.022221239 3.836658508 0.056222052 Residual 46 0.266423756 0.005791821 Total 47 0.288644995

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.01132603 0.011271403 -1.004846556 0.320227487 -0.034014186 0.011362126 -0.034014186 0.011362126 X Variable 1 1.014801849 0.518089364 1.95873901 0.056222052 -0.028057936 2.057661634 -0.028057936 2.057661634

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.273388185 R Square 0.0747411 Adjusted R Square 0.047527602 Standard Error 0.078745538 Obser vat ions 36

ANOVA df SS MS F Significance F Regression 1 0.017030486 0.017030486 2.746471698 0.10666988 Residual 34 0.21082923 0.00620086 Tot al 35 0.227859715

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.00430355 0.01352662 -0.318154138 0.752314045 -0.031792949 0.023185849 -0.031792949 0.023185849 X Variable 1 1.017270748 0.613831247 1.657248231 0.10666988 -0.230184426 2.264725923 -0.230184426 2.264725923

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.347274626 R Square 0.120599666 Adjusted R Square 0.080626924 Standard Error 0.071618621 Obser vat ions 24

ANOVA df SS MS F Significance F Regression 1 0.015475122 0.015475122 3.017047583 0.096376376 Residual 22 0.112842992 0.005129227 Total 23 0.128318114

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002416109 0.015413707 0.156750694 0.876870949 -0.029549962 0.034382181 -0.029549962 0.034382181 X Variable 1 1.264380047 0.727924864 1.736965049 0.096376376 -0.245243716 2.77400381 -0.245243716 2.77400381

140

7 Year Time Period Adjusted Est. (months) R² Beta ke 72 10.52% 0.75 10.10% Published Beta 1.01 60 7.02% 0.85 10.94% Risk-Free Rate .0420 48 5.78% 1.02 12.26% 36 4.77% 1.02 12.25% 24 8.08% 1.27 14.20%

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.343265646 R Square 0.117831304 Adjusted R Square 0.105228894 Standard Error 0.071941785 Obser vat ions 72

ANOVA df SS MS F Significance F Regression 1 0.048391547 0.048391547 9.349902461 0.003157353 Residual 70 0.362293434 0.00517562 Total 71 0.410684981

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000760481 0.008498104 0.089488367 0.92894935 -0.016188453 0.017709416 -0.016188453 0.017709416 X Variable 1 0.747430186 0.244437083 3.057761021 0.003157353 0.259915801 1.23494457 0.259915801 1.23494457

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.293232465 R Square 0.085985279 Adjusted R Square 0.070226404 St an d ar d Er r o r 0.073478503 Observat ions 60

ANOVA df SS MS F Significance F Regression 1 0.029459102 0.029459102 5.456308358 0.022976555 Residual 58 0.313147247 0.00539909 Total 59 0.34260635

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004051424 0.009754198 -0.415351805 0.679416979 -0.023576571 0.015473724 -0.023576571 0.015473724 X Variable 1 0.853179364 0.365250559 2.335874217 0.022976555 0.12205094 1.584307789 0.12205094 1.584307789

141

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.278963662 R Square 0.077820725 Adjusted R Square 0.057773349 St an d ar d Er r o r 0.076069538 Observat ions 48

ANOVA df SS MS F Significance F Regression 1 0.022462563 0.022462563 3.881841013 0.054847791 Residual 46 0.266182432 0.005786575 Total 47 0.288644995

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.011200325 0.011249202 -0.995655066 0.324626613 -0.033843794 0.011443144 -0.033843794 0.011443144 X Variable 1 1.020374898 0.517894017 1.970238821 0.054847791 -0.022091674 2.06284147 -0.022091674 2.06284147

SUM M ARY OUTPUT

Regression Statistics Multiple R 0.273698762 R Square 0.074911012 Adjusted R Square 0.047702513 St an d ar d Er r o r 0.078738307 Observat ions 36

ANOVA df SS MS F Significance F Regression 1 0.017069202 0.017069202 2.753220992 0.106256613 Residual 34 0.210790513 0.006199721 Tot al 35 0.227859715

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.004244581 0.013515929 -0.314042862 0.755407339 -0.031712252 0.023223091 -0.031712252 0.023223091 X Variable 1 1.018771379 0.613982792 1.659283277 0.106256613 -0.228991772 2.26653453 -0.228991772 2.26653453

SU M M ARY OU TPU T

Regression Statistics Multiple R 0.347567662 R Square 0.12080328 Adjusted R Square 0.080839793 Standard Error 0.07161033 Obser vat ions 24

ANOVA df SS MS F Significance F Regression 1 0.015501249 0.015501249 3.022841301 0.096076803 Residual 22 0.112816865 0.005128039 Total 23 0.128318114

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.002433163 0.015407514 0.157920512 0.87595997 -0.029520066 0.034386391 -0.029520066 0.034386391 X Variable 1 1.265702648 0.727987655 1.73863202 0.096076803 -0.244051337 2.775456633 -0.244051337 2.775456633

142

Discounted Dividends Approach WACC(BT) 0.0848 Kd 0.04724 Ke 0.1011 Perp 0 123456 7 8 9 1011 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Earnings 320574 353978 390863 431591 476562 526220 581052 641598 708452 782273 Dividends 76930 84946 93797 103571 114363 126280 139438 153968 170011 187726 197113 Book Value of Equity 1208393 Cash From Operations 493 562 640 730 832 949 1082 1233 1406 1603 Cash Investments 113 127 140 155 171 189 208 230 254 280

PV Factor 0.908 0.825 0.749 0.680 0.618 0.561 0.510 0.463 0.420 0.382 PV Dividends Year by Year 69866 70063 70260 70458 70657 70856 71055 71255 71456 71657 Total PV of Annual Dividends$ 707,582.83 32% Continuing (Terminal) Value Perpetuity $3,857,390 PV of Terminal Value Perpetuity $ 1,472,400 68% g Estimated Price per Share (end of 2006)$ 15.52 100% 0 0.03 0.05 0.07 0.1 Implied Nov. 4, 2007 Share Price$ 16.82 0.06 $19.62 $33.46 $88.82 N/A N/A Observed Share Price$ 23.24 ke 0.08 $14.24 $19.58 $29.09 $76.61 N/A Initial Cost of Equity (You Derive) 10.11% 0.09 $12.47 $16.14 $21.65 $38.18 N/A Perpetuity Growth Rate (g) 5% 0.1011 $10.93 $13.47 $16.82 $24.48 $558.20 0.12 $8.99 $10.46 $12.14 $15.17 $31.05 0.14 $7.53 $8.43 $9.35 $10.81 $15.72

<19.24 >27.24 Fairly Valued within 20% of $23.24

Discounted Free Cash Flows Family Dollar

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 P Cash Flow from Operations 493 562 640 730 832 949 1082 1233 1406 1603 Cash Provided (Used) by Investing Activities -113 -127 -140 -155 -171 -189 -208 -230 -254 -280 Free Cash Flow (to firm) 380 435 500 575 661 760 874 1,003 1,152 1,323 1400 PV factor (discount rate 8.48% WACC) 0.922 0.850 0.783 0.722 0.666 0.614 0.566 0.521 0.481 0.443 Present Value of Free Cash Flows 350.3 369.6 391.7 415.2 440.0 466.4 494.4 523.0 553.7 586.2 Total Present Value of Annual Cash Flows 4,591 Continuing (Terminal) Value (assume no growth) 16509.43 Present Value of Continuing (Terminal) Value 7,315 Sensitivity Analysis Value of the Firm (end of 2006) 11,906 3102.7 g Book Value of Debt and Preferred Stock 1,315 0 0.01 0.03 0.05 Value of Equity (end of 2006) 10,591 WACC 0.07 $91.76 $103.00 $142.33 $260.31 Estimated Value per Share Nov. 4, 2007 70.23 0.0848 $70.23 $76.71 $96.78 $139.92 Earnings Per Share 2.28 0.09 $64.44 $69.88 $86.22 $118.90 Dividends per share 0.584 0.1 $55.11 $59.08 $70.45 $90.90 Book Value Equity Per Share $8.60 0.11 $47.60 $50.57 $58.74 $72.37

Actual Price per share $23.24 < 19.24 overvalued > 27.24 undervalued Fairly valued

143

RESIDUAL INCOME WACC(AT) 0.0795 Kd 0.04724 Ke 0.1011

0 1234567891011 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 P Earnings 320574 353978 390863 431591 476562 526220 581052 641598 708452 782273 Dividends 76930 84946 93797 103571 114363 126280 139438 153968 170011 187726 Book Value of Equity 1208393 1452037 1721069 2018135 2346154 2708353 3108293 3549907 4037537 4575978 5170525 Cash From Operations 493 562 640 730 832 949 1082 1233 1406 1603 Cash Investments 113 127 140 155 171 189 208 230 254 280 Actual Earnings 320574 353978 390863 431591 476562 526220 581052 641598 708452 782273 "Normal" (Benchmark) Earnings 122169 146801 174000 204033 237196 273814 314248 358896 408195 462631 Residual Income (Annual) 198406 207177 216863 227557 239366 252406 266804 282702 300257 319642 341046 PV Factor 0.908 0.825 0.749 0.680 0.618 0.561 0.510 0.463 0.420 0.382 PV of Annual Residual Income 180189 170879 162444 154804 147887 141624 135958 130832 126198 122010 Total PV of Annual Residual Income 1472825.59 Continuing (Terminal) Value Perpetuity g 3373351 PV of Terminal Value Perpetuity 1417818.62 0 -0.1 -0.2 -0.3 -0.4 -0.5 Initial Book Value of Equity 1208393 ke 0.08 44.93 33.40 30.10 28.54 27.63 27.03 Book Value of Liabilities 0.09 37.76 29.69 27.19 25.97 25.25 24.77 Estimated Price per Share (end of 1987) 29.18 0.1011 31.62 26.18 24.35 23.44 22.89 22.52 Time consistant implied price(11/01/2007) 31.62 0.12 24.06 21.33 20.31 19.78 19.45 19.23 Observed Share Price $23.14 0.13 21.07 19.23 18.51 18.13 17.89 17.72 Initial Cost of Equity (You Derive) 0.1011 0.14 18.58 17.39 16.91 16.64 16.47 16.36 Perpetuity Growth Rate (g)0 < 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.14

AEG VALUATION WACC(AT) 0.0795 Kd 0.04724 Ke 0.1011 012345678 9Perp Forecast Years 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Earnings 320574 353978 390863 431591 476562 526220 581052 641598 708452 782273 Dividends 76930 84946 93797 103571 114363 126280 139438 153968 170011 187726 DPS invested at 10.11% (DRIP) 7778 8588 9483 10471 11562 12767 14097 15566 17188 Cum-Dividend Earnings 361756 399451 441073 487033 537782 593819 655695 724018 799461 Normal Earnings 352984 389765 430379 475224 524743 579421 639797 706463 780077 Abnormal Earning Growth (AEG) 8771.399 9685.378 10694.595 11808.972 13039.467 14398.179 15898.469 17555.090 19384.330 21404.177 PV Factor 0.908 0.825 0.749 0.680 0.618 0.561 0.510 0.463 0.420 PV of AEG 7966.03 7988.46 8010.95 8033.50 8056.12 8078.80 8101.55 8124.36 8147.23 R.I. check figures 8771.399 9685.378 10694.595 11808.972 13039.467 14398.179 15898.469 17555.090 19384.330

Core Earnings 195111.00 Total Pv of annual AEG 72507.00 Continuing (Terminal) Value $ 211,712.93 PV of Terminal Value 88982.89 Total PV of total AEG 161489.90 Total Average Earnings Perp (t+1) 356600.90 Sensitivity Analysis Capitalization Rate (Ke) 10.11% g 0 -0.1 -0.2 -0.3 -0.4 Intrinsic Value Per Share (end of 2006)$ 25.11 0.08 50.69 39.50 36.30 34.79 33.91 Time Consistent Implied Price$ 27.21 Ke 0.09 37.24 30.84 28.85 27.88 27.30 Nov 1, 2007 Observed Price$ 23.24 0.1011 27.20 23.83 22.69 22.13 21.79 Ke 10.11% 0.12 16.78 15.87 15.53 15.35 15.24 g 0 0.14 10.57 10.66 10.70 10.72 10.73 Actual Price per Share $23.24 19.24 < 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

144

Long Run ROE Residual Income Model

g ke 0.12 0.14 0.16 0.18 0.2 0.06 N/A 0.37 2.01 3.11 3.9 0.08 N/A 0.49 2.52 3.73 4.54 0.1011 N/A 0.75 3.42 4.73 5.51 0.13 14.28 2.92 6.71 7.47 7.79 0.15 4.76 N/A 20.13 12.44 10.91

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24 ROE ke 0.09 0.12 0.1366 0.16 0.18 0.06 12.9 17.2 19.58 22.94 25.81 0.08 9.68 12.9 14.69 17.2 19.36 0.1011 7.66 10.21 11.62 13.61 15.32 0.13 5.96 7.94 9.04 10.59 11.91 0.15 5.16 6.88 7.84 9.18 10.32

< 19.24 overvalued > 27.24 undervalued Fairly valued within 20% of $23.24

g ROE 0.12 0.14 0.16 0.18 0.2 0.09 13.65 11.06 10.22 9.81 9.57 0.12 4.42 5.84 6.54 6.96 0.1366 N/A 0.75 3.42 4.73 5.51 0.16 N/A N/A 2.18 3.48 0.18 N/A N/A N/A 1.74

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< 19.24 overvalued > 27.24 undervalued Z - Score Analyisis Fairly valued within 20% of $23.24 Z-Score = 2002 2003 2004 2005 2006 Working Capital 525,079 561,161 489,727 460,157 432,737 1.2 x + Total Assets 1,754,619 1,985,695 2,224,361 2,409,501 2,523,029

Retained Earnings 1,118,015 1,315,600 1,498,890 1,654,861 1,546,366 1.4 x + Total Assets 1,754,619 1,985,695 2,224,361 2,409,501 2,523,029

EBIT 341,621 389,725 403,362 338,810 317,305 3.3 x + Total Assets 1,754,619 1,985,695 2,224,361 2,409,501 2,523,029

Market Value of Equity 4,933,440 6,914,522 4,516,867 3,315,805 3,856,161 0.6 x + Book Value of Liabilities 599,671 674,726 887,279 981,435 1,314,636

Sales 4,162,652 4,750,171 5,281,888 5,824,808 6,394,772 1.0 x Total Assets 1,754,619 1,985,695 2,224,361 2,409,501 2,523,029

2002 2003 2004 2005 2006 0.2993 0.2826 0.2202 0.1910 0.1715

0.6372 0.6625 0.6739 0.6868 0.6129

RAW 0.1947 0.1963 0.1813 0.1406 0.1258

8.2269 10.2479 5.0907 3.3785 2.9333

2.3724 2.3922 2.3746 2.4174 2.5346

2002 2003 2004 2005 2006 0.3591 0.3391 0.2642 0.2292 0.2058

0.8921 0.9276 0.9434 0.9615 0.8581

Weighted 0.6425 0.6477 0.5984 0.4640 0.4150

4.9361 6.1487 3.0544 2.0271 1.7600

2.3724 2.3922 2.3746 2.4174 2.5346

Z-Score 9.2022 10.4553 7.2350 6.0993 5.7734

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(Revised) Z - Score Analyisis

Z-Score = 2002 2003 2004 2005 2006 Working Capital 525,079 561,161 489,727 460,157 432,737 1.2 x + Total Assets 2,336,309 2,664,037 3,044,573 3,369,833 3,548,335

Retained Earnings 1,118,015 1,315,600 1,498,890 1,654,861 1,546,366 1.4 x + Total Assets 2,336,309 2,664,037 3,044,573 3,369,833 3,548,335

EBIT 372,625 425,881 447,079 389,996 371,954 3.3 x + Total Assets 2,336,309 2,664,037 3,044,573 3,369,833 3,548,335

Market Value of Equity 4,933,440 6,914,522 4,516,867 3,315,805 3,856,161 0.6 x + Book Value of Liabilities 1,181,361 1,353,068 1,707,491 1,941,767 2,339,942

Sales 4,162,652 4,750,171 5,281,888 5,824,808 6,394,772 1.0 x Total Assets 2,336,309 2,664,037 3,044,573 3,369,833 3,548,335

2002 2003 2004 2005 2006 0.2247 0.2106 0.1609 0.1366 0.1220

0.4785 0.4938 0.4923 0.4911 0.4358

RAW 0.1595 0.1599 0.1468 0.1157 0.1048

4.1761 5.1103 2.6453 1.7076 1.6480

1.7817 1.7831 1.7349 1.7285 1.8022

2002 2003 2004 2005 2006 0.2697 0.2528 0.1930 0.1639 0.1463

0.6700 0.6914 0.6892 0.6875 0.6101

Weighted 0.5263 0.5275 0.4846 0.3819 0.3459

2.5056 3.0662 1.5872 1.0246 0.9888

1.7817 1.7831 1.7349 1.7285 1.8022

Z-Score 5.7533 6.3209 4.6889 3.9864 3.8934 147

References

1. Family Dollar’s website www.familydollar.com 2006 10K Annual Report 2001 10K - 2007 10K

2. Dollar Tree’s website www.dollartree.com 2006 10K Annual Report 2001 10K – 2007 10K

3. 99 Cent Only Store’s website www.99only.com 2006 Annual Report 2001 10K – 2007 10K

4. Dollar General’s website www.dollargeneral.com 2006 Annual Report 2001 10K – 2007 10K

5. QuickMBA www.quickmba.com

6. WIKIPEDIA www.wikipedia.com

7. Reuters www.reuters.com

8. Answers www.answers.com

9. Hoovers www.hoovers.com

10. Investopedia www.investopedia.com

11. Business Analysis & Valuation by Palepu & Healy

12. WiseGeek www.wisegeek.com

13. Yahoo! Finance www.finance.yahoo.com

14. NYU Stern www.stern.nyu.edu

15. St. Louis Fed FRED date http://research.stlouisfed.org/fred2/

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