Case 32 California Pizza Kitchen
- Summarize the company history and the case briefly.
- Using the scenarios in case Exhibit 9, what role does leverage play in affecting the return on equity (ROE) for CPK? What about the cost of capital?
- Based on the analysis in case Exhibit 9, what is the anticipated CPK share price under each scenario? How many shares will CPK be likely to repurchase under each scenario? What role does the tax deductibility of interest play in encouraging debt financing at CPK?
- What capital structure policy would you recommend for CPK?
Exhibit 9 CALIFORNIA PIZZA KITCHEN Pro Forma Tax Shield Effect of Recapitalization Scenarios (Dollars in thousands, except share data: figures based on end of June 2007) Debt/Total Capital 20% Actual 10% 30% Interest rate (1) Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 30,054 Earnings before income taxes and interest Interest expense Earnings before taxes Income taxes Net income 30,054 9,755 30,054 1,391 28,663 9,303 19,359 30,054 2,783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 20,299 Book value: Debt Equity Total capital 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Market value: Debt) 0 Equity 643,773 643,773 22,589 628,516 651,105 45,178 613,259 658,437 67,766 598,002 665,769 Market value of capital Notes: Interest rate of CPK's credit facility with Bank of America: LIBOR + 0.80%. EBIT includes interest income. Market values of debt equal book values. "Actual market values of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million). Source: Case writer analysis based on CPK financial data. Exhibit TNI CALIFORNIA PIZZA KITCHEN Pro Forma Tax Shield Effect of Recapitalization Scenarios (Dollars in thousands, except share data; figures based on end of June 2007) Debt/Total Capital Actual 10% 20% 30% Interest rate) Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 30,054 Earnings before income taxes and interest(2) Interest expense Earnings before taxes Income taxes Net income 30,054 9,755 20,299 30,054 1,391 28,663 9,303 19,359 30,054 2,783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 Book value: Debt Equity Total capital 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Return on equity Market value: Debt") 0 2 2,589 45,178 67,766 Equity" Market value of capital Market value of Debt/MV of Capital $22.10 Hint: find the increase in value of the firm from no debt to debt and divide by initial shares outstanding Price per share Shares repurchased (thousands) Shares outstanding (thousands) Earnings per share Price to earning ratio 29.130 Beta Cost of equity WACC Hint: use market values of debt and equity Hint: for risk-free rate use 10-year bond rate, market premium is 5% Exhibit 9 CALIFORNIA PIZZA KITCHEN Pro Forma Tax Shield Effect of Recapitalization Scenarios (Dollars in thousands, except share data: figures based on end of June 2007) Debt/Total Capital 20% Actual 10% 30% Interest rate (1) Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 30,054 Earnings before income taxes and interest Interest expense Earnings before taxes Income taxes Net income 30,054 9,755 30,054 1,391 28,663 9,303 19,359 30,054 2,783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 20,299 Book value: Debt Equity Total capital 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Market value: Debt) 0 Equity 643,773 643,773 22,589 628,516 651,105 45,178 613,259 658,437 67,766 598,002 665,769 Market value of capital Notes: Interest rate of CPK's credit facility with Bank of America: LIBOR + 0.80%. EBIT includes interest income. Market values of debt equal book values. "Actual market values of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million). Source: Case writer analysis based on CPK financial data. Exhibit TNI CALIFORNIA PIZZA KITCHEN Pro Forma Tax Shield Effect of Recapitalization Scenarios (Dollars in thousands, except share data; figures based on end of June 2007) Debt/Total Capital Actual 10% 20% 30% Interest rate) Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 30,054 Earnings before income taxes and interest(2) Interest expense Earnings before taxes Income taxes Net income 30,054 9,755 20,299 30,054 1,391 28,663 9,303 19,359 30,054 2,783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 Book value: Debt Equity Total capital 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Return on equity Market value: Debt") 0 2 2,589 45,178 67,766 Equity" Market value of capital Market value of Debt/MV of Capital $22.10 Hint: find the increase in value of the firm from no debt to debt and divide by initial shares outstanding Price per share Shares repurchased (thousands) Shares outstanding (thousands) Earnings per share Price to earning ratio 29.130 Beta Cost of equity WACC Hint: use market values of debt and equity Hint: for risk-free rate use 10-year bond rate, market premium is 5%
