1. You are trying to estimate the beta of a private firm that manufactures home appliances. You have managed to obtain betas for publicly traded firms that also manufacture home appliances.

FIRM BETA DEBT MV of Equity

Black & Decker. 1.40 $2,500 $3,000

Fedders Corp. 1.20 $5 $200

Maytag Corp. 1.20 $540 $2,250

National Presto 0.70 $8 $300

Whirlpool 1.50 $2,900 $4,000

The private firm has a debt equity ratio of 25% and faces a tax rate of 40%. The publicly traded firms all have marginal tax rates of 40% as well.

A) Estimate the beta for the private firm.

B) What concerns, if any, would you have about using betas of comparable firms?

In the problems following, use an equity risk premium of 5.5 percent if none is specified.

2. Derra Foods is a specialty food retailer. In its balance sheet, the firm reports $1 billion in book value of equity and no debt, but it has operating leases on all its stores. In the most recent year, the firm made $85 million in operating lease payments, and its commitments to make lease payments for the next five years and beyond are:

YEAR Operating Lease Expense

1 $90 million

2 $90 million

3 $85 million

4 $80 million

5 $80 million

6-10 $75 million annually

If the firms current cost of borrowing is 7%, estimate the debt value of operating leases. Estimate the book value debt-to-equity ratio.