California Pizza Kitchen has been runing since 1985 preponderantly in California. As of June 2007, they had 213 retail locations in the US and abroad. Analysts have put estimations on the potency of 500 full service locations. CPK’s scheme includes the gap of 16 to 18 new locations this twelvemonth including the shutting of one location. In the 2nd one-fourth of 2007, gross increased 16 % while comparable eating house gross revenues grew by 5 % . Performing relatively good against its rivals, CPK’s stock has been depressed late falling to $ 22.
10 in June doing their P/E peer to 31.9 clip current net incomes. In comparing with BJ’s Restaurants with a P/E of 48.9, CPK appears undervalued. CPK’s direct rival, BJ’s pays no dividend and has a similar beta and therefore it makes for a good comparative company.
Despite uncertainness in the industry and general hapless public presentation among rivals, CPK is executing marginally better than the overall industry. Susan Collyns has several determinations that need to be made.
Her two primary issues are how to finance enlargement and the firm’s most appropriate capital construction. The focal point of this analysis will be on the alteration in capital construction through the redemption of portions at today’s market monetary value of $ 22.10. The consequence of the redemption will be analyzed from an EBIT breakeven, ROE, EPS, Cost of Capital, and stock monetary value position. It should be noted that there is an $ 85 million cost to fund farther enlargement of their full service eating houses. This is a known disbursal that will hold to be financed by publishing equity or leveraging the company by taking on debt.
How does debt add value to CPK?By reasonably prying up and buy backing portions, companies can usually increase their EPS because of the involvement revenue enhancement shield. This typically makes the cost of publishing debt cheaper, than that of publishing equity. The involvement revenue enhancement shield will cut down nonexempt income so that when debt is used to buy back portions outstanding, there will be a subsequent addition in EPS. A similar consequence happens with ROE. Because less of the company is being financed with equity, net incomes are spread out over less equity and hence addition ROE. Cost of Capital
CPK has an equity cost of capital of 5.03 % and a debt funding rate of 6.16 % .
5.03 % = 0.052 + 0.85 ( 0.05-0.052 )
10 % Debt scenario
30 % Debt scenario
Based on our WACC computations pretermiting revenue enhancement, we found that as CPK acquires debt, their cost of capital additions. Based on this determination, it is non reasonable for CPK to take on debt. If their cost of capital additions, it will impact every undertaking they take on by take downing their returns on every capital undertaking. This can be seen in the graph below.
Because the cost of debt is higher than the firm’s unlevered cost of capital and their cost of equity, adding debt to the concern does non add value to California Pizza from a cost of capital position. Return on Equity
The Return on Equity is lifting as the house takes on more debt, going more leveraged. This is true as involvement payments to creditors are revenue enhancement deductible and therefore the company is able to bring forth a higher return on fewer portions outstanding because of the redemption. The consequence is that a higher proportion of debt in the firm’s capital construction leads to higher ROE as net incomes are spread over a decreased sum of equity.
0 % DebtShare Price = E/CSOShare Price = 643 773 000/29 130 000Share Price = 22.10 $
10 % DebtShare Price = E/CSOShare Price = 628 516 000/28 108 000Share Price = 22.36 $
20 % DebtShare Price = E/CSOShare Price = 613 259 000/27 086 000Share Price = 22.64 $
30 % DebtShare Price = E/CSOShare Price = 598 002 000/26 064 000Share Price = 22.94 $
The portion monetary value of the firm’s stock rises as it increases its debt. Share monetary value being determined by the Entire Market Value of Equity divided by the current figure of portions outstanding. As the house increases its purchase, it buys back portions, every bit good as reduces its equity. The rate that equity lessenings is smaller than that of portions being bought back, therefore doing an addition in portion monetary value.
Shares OutstandingShares outstanding lessening as the house takes on more debt. The ground being is that the house buys back portions with the freshly acquired hard currency from publishing debt. By leveraging their company, California Pizza Kitchen adds value to their Entire Market Value of Capital. They besides increase their portion monetary value. It should be considered that as they increase their debt to equity ratio, they besides increase their hazard of default. Breakeven degrees of EBIT for each scenario
No Leverage10 %20 %30 %Debt
225894517867766Equity225888203299180710158122Entire Capital225888225888225888225888Interest on Debt
CSO29130281082708626064CSOU/CSOLn/a1.0361.0751.118Breakeven EBITn/a$ 40,166.67$ 37,106.67$ 35,373.00
EBIT/CSOU= ( EBIT-i ) /CSOL
EBIT/CSOU= ( EBIT-i ) /CSOLEBIT= ( CSOU/CSOL ) ( EBIT-i )
EBIT= ( CSOU/CSOL ) ( EBIT-i )
EBIT=1.036 ( EBIT-i )
EBIT= ( 1.075 ) ( EBIT-i )EBIT=1.036 ( EBIT-1391 )
EBIT=1.075 ( EBIT-2783 )-.036EBIT= -1446
EBIT/CSOU= ( EBIT-i ) /CSOL
EBIT= ( CSOU/CSOL ) ( EBIT-i )
EBIT= ( 1.118 ) ( EBIT-i )
EBIT=1.118 ( EBIT-4174 )
The consequences from the breakeven EBIT analysis are calculated to current market conditions. The market has equities ; in peculiar, California Pizza priced its monetary values at really high ratings. This is exhibited by California Pizza’s price/earnings ratio of 31.9. Because of this exalted rating, if California Pizza is traveling to buy back portions at the current market monetary value of $ 22.10, it will be dearly-won to investors. It will be particularly expensive to investors to purchase back portions if California Pizza utilizing debt because their cost of debt is higher than their cost of equity. California Pizza has diminishing interrupt even EBITs because the numerator ( involvement disbursal ) is spread outing with each scenario of debt financed stock redemptions. Because the cost of debt is higher than the cost of equity, the breakeven EBIT is diminishing with each increased debt scenario. What happens to ROE and EPS if… ?
As the company changes their capital construction to integrate varying degrees of debt, they are cut downing their common portions outstanding and equity within the company. In all three instances, ROE continues to lift as more debt is added in. When EBIT is at a point that is above the Break-even point, ROE increases at a much larger rate, compared to if EBIT is below the Break-even point. As seen under the 100 % EBIT chart, ROE increases at a much higher rate than compared to the 50 % decreased EBIT tabular arraies, which is below the break-even EBIT.
Actual10 %20 %30 %Exabit30,05430,05430,05430,054Interest
1,3912,7834,174Taxs9,7559,3038,8528,400Nickel20,22919,36018,41917,480Roe8.99 %9.52 %10.19 %11.05 %EPS$ 0.69$ 0.69$ 0.68$ 0.67Because the redemption cost of portions is so high, the figure of portions outstanding after the redemption is non plenty to countervail the extra involvement costs doing for a decrease in EPS.
EBIT Reduced 50 %
Actual10 %20 %30 %Exabit15,02715,02715,02715,027Interest01,3912,7834,174Taxs4,8774,4263,9743,523Nickel10,1509,2108,2707,330Roe4.49 %4.53 %4.58 %4.64 %EPS$ 0.35$ 0.33$ 0.31$ 0.28
When EBIT is reduced by 50 % , EPS shows a worsening tendency from 0.35 $ -0.28 $ . In this instance, EPS declines because the involvement from the added debt is diminishing your EPS. When EBIT is reduced by 50 % the EPS lies below the break-even point, any extra debt at this point is a disadvantage.
100 % EBIT
Actual10 %20 %30 %Exabit60,10860,10860,10860,108Interest01,3912,7834,174Taxs19,51019,05818,60718,155Nickel40,59839,65838,71837,779Roe17.97 %19.51 %21.43 %23.89 %EPS$ 1.39$ 1.41$ 1.43$ 1.45
When EBIT is increased by 100 % , EPS shows an increasing tendency from $ 1.39 – $ 1.45. EPS increases as more debt is added because it is above the break-even EBIT point. Because we are above the EBIT breakeven point, the steadfast benefits from the increased purchase which raises the EPS as more debt is added. Conclusion & A ; Recommendations
In decision, it is the analysts’ recommendation that California Pizza Kitchen alter its capital construction by publishing debt and buy backing portions. This instates a revenue enhancement shield, which reduces nonexempt income, increases the value of the company, and in bend increases the return to stockholders. Subsequently leting net incomes to be spread out over fewer portions and as the market increases, stockholders will hold greater ROE and EPS.
Cite this California Pizza Kitchen Case Sample
California Pizza Kitchen Case Sample. (2017, Jul 19). Retrieved from https://graduateway.com/california-pizza-kitchen-case-essay-sample-2737/