QUESTIONS AND SHORT PROBLEMS

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

1. 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 firm's current cost of borrowing is 7%, estimate the debt value of operating leases. Estimate the book value debt-to-equity ratio.

2. Assume that Derra Foods, in the preceding problem, reported earnings before interest and taxes (with operating leases expensed) of $200 million. Estimate the adjusted operating income, assuming that operating leases are capitalized.