Please support to provide answers for the following in Case Study : California Pizza Kitchen (CPK)

You are required to answer below questions:

1.What is going on at CPK? In what way can Susan Collyns facilitate the success of CPK?

2.May be we can all be right. Is there a case for that?

3.How does debt add value to CPK? 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?

4.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?

5.What is the case for not doing the recapitalization?

6. What capital structure policy would you recommend for CPK?

Synopsis

This case examines the question of financial leverage at California Pizza Kitchen (CPK) in July 2007. With a highly profitable business and an aversion to debt, CPK management is considering a debt-financed stock buyback program. The case is intended to provide an introduction to the Modigliani and Miller capital structure irrelevance propositions and the concept of debt tax shields. With the background of a pizza company, the case provides an engaging context to discuss the "pizza graphs" that are commonly used in corporate finance curriculum to illustrate the wealth effects of capital structure decisions.

Concepts in Practice

1.The Modigliani-Miller intuition of capital structure irrelevance;

2.How the cost of equity is affected by capital structure decisions

3.Financial Risk and the levered-beta capital asset pricing model (CAPM) equation;

4.Interest tax deductibility and the valuation tax shields;

5.Importance of debt capacity in a growing business

Hints for Analysis

In assessing the effect of leverage on the cost of capital, you may assume that the a firms CAPM beta can be modeled in the following manner.

_L = _v [ 1 + (1-T) D/E]

Where,

_v is the firms beta without leverage,

T is the corporate income tax rate

D is the market value of the debt

E is the market value of equity

In your estimate, you may assume that the market risk premium in CAPM is 5%.

Interest rate of CPKs credit facility with the Bank of America: LIBOR + 0.8% = 6.16%

EBIT includes interest income

Market value of debt = book value of the debt

Actual market value of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million)