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California pizza Kitchen Case Solution
While the California Pizza Kitchen restaurant industry is strife with challenges such as increasing commodity prices and rising labor costs, California Pizza Kitchen, a company founded in 1985 in California inspired by gourmet pizza offerings, has been outperforming its customers with stellar growth in revenues and profits. All three revenue sources of the pizza chain which include sales at company-owned restaurants, royalties from its franchised restaurants, and royalties from CPK’s partnerships have shown tremendous growth due to rising popularity with the customers and the figures on the balance sheet are optimistic about future growth and performance of the company. However, the industry challenges have contributed to a 10% decline in share price in 2007. To counter this problem, the CFO Susan Collyns, is considering repurchasing of company shares. Hence California Pizza Kitchen is faced with a crucial capital structure decision over whether to secure debt financing to fund share repurchase and open new outlets to achieve growth targets set by senior management.
Following questions are answered in this case study solution
In what ways can Susan Collyns facilitate the success of California Pizza Kitchen?
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: bL = bU[1 + (1 − T)D/E], where bU 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.
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?
What capital structure policy would you recommend for CPK?
Case Analysis for California pizza Kitchen
1. In what ways can Susan Collyns facilitate the success of California Pizza Kitchen?
While the sales for California Pizza Kitchen were up by 5% in the second quarter of 2007, the share price had declined by 10% during the month of June due to adversities faced by the restaurant industry. The Chief Financial Officer, Susan Collyns is faced with the challenge of improving the company’s share price while taking steps that will sustain the success of CPK and lead to improved performance of CPK.
California Pizza Kitchen has three primary revenue streams, sales at company-owned restaurants, royalties from its franchised restaurants, and royalties from CPK’s partnership with Kraft Foods to sell its frozen pizzas in supermarkets. Susan should ensure that CPK sustains this diversification in revenue sources and that all three streams are improved and given equal importance while continuing to explore new avenues and potential partnerships to increase sales and gain a competitive advantage.
Customers have had a good response to the food items offered by California Pizza Kitchen which has led to an exponential growth in popularity, CPK can work on furthering increasing customer base for which Susan Collyns should allocate greater funds for marketing as the company was not currently spending much on its own marketing and was solely meeting the marketing requirements of the franchise agreement.
The strong balance sheet provides growth and expansion potential. This coupled with thriving revenue and profitability means that CPK can be considering expanding its reach to achieve the greater success which it plans to do so by opening at least 16-18 new branches. Doing so would require significant capital expenditure of around $85 million which can be provided through the company’s internally generated funds which are high as seen by positive balance sheet figures or by making use of debt financing.
California Pizza Kitchen is faced with a capital structure decision for which a share repurchase is proposed. This share repurchase will contribute to the success of the firm by leading to increased share price that will improve the image of CPK in the market. Hence Susan should obtain debt financing to repurchase company shares which will also give the company advantages in form of an interest tax shield.
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: bL = bU[1 + (1 − T)D/E], where bU 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.
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