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? In assessing the effect of leverage on the cost of capital, you may assume that a firms CAPM beta can be modeled in the following manner: ?_L = ?_U[1 + (1 ? T)D/E], where ?_U is the firms beta without leverage, T is the corporate income tax rate, D is the market value of debt, and E is the market value of equity.

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?

Exhibit 9 CALIFORNIA PIZZA KTTCHEN 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 ) Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% Earnings before income taxes and interest21 Interest expense 30,054 0 30,054 9,755 20,299 30,054 1,391 28,663 9.303 19.359 30,054 783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 Earnings before taxes Income taxes Net income Book value: Debt Equity 0 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Total capital Market value: 22,589 628.516 651,105 45,178 613,259 658,437 67,766 598,002 665,769 Debt) 643.773 643,773 ul 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