California Pizza Kitchen

Preparatory Questions for California Pizza Kitchen

1 - California Pizza Kitchen introduction. In what ways can Susan Collins facilitate the cusses of CPK?

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2. Using the scenarios in case Exhibit 9, what roles does leverage play in affecting the return on equity (ROE) for CPK? What about the cost of capital?

a. Leverage increases Beta for the firm since debt to equity ratio increases from unlevered beta. We use 10 year Treasury bond as our risk free rate and for market risk premium we use current prime lending rate for June 2007 minus10 year TRSY bond. Using these assumptions with increase in Debt, cost of equity increases for all the different capital structures. Interesting observation with cost of capital is that having debt in your capital structure decreases your WACC because of the benefit of tax shield. b. As equity value decreases with increase in debt value, ROE decreases with debt increasing in the capital structure.

3. Based on the analysis in Exhibit 9 (or additional analysis beyond the case exhibit), what is the anticipated CPK share price for different leverage scenarios? How many shares will CPK be likely to repurchase under these scenarios? a. At the bottom Exhibit 9, we have assumed all the debt the firm raises it purchases shares for it. Eg: with 20% debt CPK’s share price will be 22.60 and will be able to purchase 2,044 at $22.10. We recommend CPK to reach out to their investment bank and request a block trade agreement where they will be able to purchase a large amount of shares in private without spooking or signaling the market of a large movement.

4. What capital structure policy for CPK would you recommend? a. In Exhibit 9, I added many different capital structures but I am unable to evaluate the optimal capital structure because D/E calculation isn’t correct. Group, please check the formula Jim as given to calc Equity values. If we can correct this we should be decrease in WACC in the beginning and then increase. That low point is our capital structure we should recommend.

Group, please divi up the work on writing the memo. Feel free to contact me for any clarification.

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