Case 33 California Pizza Kitchen

Case 33

California Pizza Kitchen

Case 33

California Pizza Kitchen

Recommendation

I would recommend to the managers of California Pizza Kitchen that they go through with a plan to issue debt equal to 30% of their total capital and repurchase outstanding shares of stock. Although there are risks to issuing debt, and abandoning the company’s debt free philosophy, there are obvious benefits to issuing debt. Restructuring the company’s capital will result in a reduction of CPK’s tax obligation, while using the funds to repurchase outstanding shares will likely result in a rise in their stock price which will benefit both the company and its shareholders.

Problem

The problem in this case is that California Pizza Kitchen’s management team is unsure whether or not they should use debt to fund a repurchase of outstanding shares. The company has not had any debt on their balance sheet since their initial public offering in 2000, as one of their founders believes in what he calls “staying power” and a conservative financial philosophy. Recently their stock has declined in price by 10%, and investors in their industry have been aggressively pressing for shareholder-friendly changes. This has led CPK’s managers to think that now might be the right time to develop a share repurchase plan, however they do not have enough cash to make this happen so they would have to issue debt.

Analysis of Problem

Modigliani & Miller’s theory regarding capital structure states that the market value of a company is determined by its earning power and the risk of its assets, rather than the structure of its financing. Although this theory holds true only in a perfect market, and California Pizza Kitchen does not operate in a perfect market, I think the theory still holds water in this case. CPK is a strong company that has proven that it can outperform its competitors, and that it has the customer base to sustain growth. For these reasons, I don’t think that adding debt to their...