Compute the cost of equity and WACC.

THE ANSWERS THAT ARE ON THE TABEL ARE WRONG. PLEASE SHOW FORMULAS IF EXCEL IS USED.

To find the cost of equity in Question #3, you should use the MM Proposition II (with taxes).

R_S=R₀+(R₀-R_B)B/S(1-tax)

Rs is the cost of equity you should find for each debt ratio.

R₀is the cost of equity without debt (the first column "Actual" case).

R_Bis the cost of debt, and you can use the interest rate.

To find B/S, you should use the market values of debt and equity, which vary with different debt ratios as shown in the table.

1. Using the scenarios in case Exhibit 32.9, what role does leverage play in affecting the cost of equity and the weighted average cost of capital (WACC) for CPK? Use market values of debt and equity to compute the cost of equity and WACC.

California Pizza Kitchen

Pro Forma Tax Shield Effect of Recapitalization Scenarios

(dollars in thousands, except share data; figures based on end of June 2007)

THE ANSWER FOR THE COST OF EQUITY AND WACC FOR THIS TABLE ARE WRONG ACCORDING TO MY INSTRUCTOR.

		Debt/Total Capital
	Actual	10%	20%	30%
Interest rate	6.16%	6.16%	6.16%	6.16%
Tax rate	32.5%	32.5%	32.5%	32.5%
Earnings before income taxes and interest	30,054	30,054	30,054	30,054
Interest expense	0	1,391	2,783	4,174
Earnings before taxes	30,054	28,663	27,271	25,880
Income taxes	9,755	9,303	8,852	8,400
Net income	20,299	19,359	18,419	17,480
Book value:
Debt	0	22,589	45,178	67,766
Equity	225,888	203,299	180,710	158,122
Total capital	225,888	225,888	225,888	225,888
Market value:
Debt	0	22,589	45,178	67,766
Equity	643,773	628,516	613,259	598,002
Market value of capital	643,773	651,105	658,437	665,769
Cost of equity - WRONG ANSWERS	9.5%	9.17%	8.85%	8.53%
WACC - WRONG ANSWERS	9.5%	9.31%	9.13%	8.96%