California Pizza Kitchen Case Study

Group 1.

Monday 18, 2012

California Pizza Kitchen case study

Executive summary.

This case examines the question of financing leverage at California Pizza Kitchen. With a highly profitable business and an aversion to debt, California Pizza Kitchen management is considering a debt financed stock buyback program. The objectives of this case are: to introduce the Modigliani-Miller intuition of capital structure irrelevance; establish how the cost of equity is affected by capital structure decisions by describing financing risk; introducing the levered-beta capital asset pricing model (CAPM); and explore the importance of debt capacity in a growing business; and Discuss interest tax deductibility and the valuation tax shields;

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To clearly analyze the case, we focused on four questions:

1. In what ways can Susan Collyns facilitate the success of CPK?

2. 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 firm’s CAPM beta can be modeled in the following manner: L = U[1 + (1 − T)D/E], where U is the firm’s 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.

3. 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?

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

In what ways can Susan Collyns facilitate the success of CPK?

She can start by reviewing and evaluating CPK’s current corporate financial policy. They used the proceeds of their initial public offering in 2000 to pay off outstanding debt and have maintained zero debt on its balance sheet. CPK values the...