California Pizza

California Pizza Kitchen

California Pizza Kitchen is a highly profitable business, which was founded in 1985. It is a debt aversion company. Recently, the stock price of the company suffered a 10% decline. CPK considers repurchasing its own stocks and trying to leverage its balance sheet with their existing line of credit. In order to continue to expand, they will use debt financing to operate.

In this case, I will analyze the pros and cons of the capital structure of CPK and give recommendations.

The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. So, the capital structure of the company is indeed the composition or 'structure' of its liabilities.

With understanding of capital structure of a firm, we can know how the company gets the financial resources. Businesses adopt various capital structures to meet both internal needs for capital and external requirements for returns on shareholders investments.

CPK used the proceeds from its 2000 initial public offering to pay off its outstanding debt, the company completely avoided debt financing. If a company doesn’t have debt financing at all, it is not healthy capital structure. Firstly, it can help you to maintain the ownership of the company. Secondly, without debt financing, the company can’t enjoy the effect of tax deduction. In most cases, the principal and interest payments on a business loan are classified as business expenses, and thus can be deducted from your business income taxes. Finally, companies can’t enjoy the low interest rate. We need to notice that there is an impact of tax deductions on the bank interest rate. Imagine that the bank is charging you 20 percent for your loan, and the government taxes you at 40 percent, then there is an advantage to taking a loan you can deduct. Take 20...