California Pizza Kitchen Essay

1. According to the article, I noticed that California Pizza Kitchen (CPK) spend only 1% of its sales on their advertising. On the other hand, CPK's competitors usually spend 3%-4% of the sales on their advertising. This means that CPK has less advertising costs compared to its competitors. However, CPK need to realize that advertising is important impact to attract more customers and improve their sales. So, increasing advertising budget is one of the important things to do for CPK's success. Then, CPK needs to repurchase the company's stock because their stock price has decreased by 10% in June, which means it is a good opportunity to repurchase their stocks at a lower price. Next, I noticed that CPK avoided their debt financing. So, CPK should increase their ROE by increasing leverage by borrowing to acquire more assets. By leveraging, CPK is able to reduce their

corporate income tax liability, which was almost $10 million in 2006.

2.

I calculated financial leverage for CPK on the below, it has financial leverage of 28.05%, 32.90%, and 33.52% respectively in 2005, 2006, and 2007. The financial leverage for CPK increased slightly in the last three years which means it is going to help to improve CPK’s ROE.

Next, I have ROE of 8.99%, 9.52%, 10.19%, and 11.05%. Based on the calculations on the above, ROE is rising when CPK takes on more debt and becomes more leveraged. Moreover, ROE of CPK increased because of CPK is expanding their business by using higher debt for a CPK’s operation.

For the cost of capital, each alternatives have a slightly different cost of capital of 5.51%, 5.46%, and 5.43% of 10%, 20%, and 30% of debt to total capital respectively. I noticed that when CPK maintains higher debt to total capital, the cost of capital reduces. To analyze that when leverage increases, it has effect on cost of capital by decreasing it slightly.

I calculated the anticipated share price and its equity. Next, I have outstanding shares of 1,010.24, 1995.49, and 2954.05 that CPK repurchases under each alternatives of 10%, 20%, and

30%.

The tax deductibility of interest for CPK is an encouraging aspect of using debt financing to repurchase its outstanding shares due to it helps to eliminate double taxation on the shareholders. This way shareholders would receive more money to purchase additional new shares, and with higher returns because the outstanding shares already have decreased. Also, we talked about the case in a class, this case situation happened right before the financial crisis in 2008. CPK hit the niche market at the time and no body competed against them.
4. For the capital structure policy I would recommend for CPK to choose within the options, to go with 30% of debt and 70% of equity. As professor has mentioned at a class, the higher risk has the higher return. Nevertheless, when CPK gets more debts, it will reduce taxes. This will result the cash flow increase by certain amount. To analyze, with 30 percent of debt financing, CPK would have financial figures of:
- Return on equity would be 11.05 percent
-Outshading shares would be over 26 millions with share price of $22.94 of each
-WACC for CPK would be 5.43%
-Lastly, the debt would be a little over $65 million and equity would be almost $600 million.