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Presented
by:

DJ Douglas
Chasiti Dixon

Case #33

November 22, 2011

8/5/12

History

Defense Attorneys Larry Flax


and Rick Rosenfield created
the first California Pizza
Kitchen in 1985 in Beverly
Hills, California

By 2007: 213 locations in 28


states and 15 international
franchises in 6 foreign
countries

Three sources of income:


sales at company owned
restaurants, royalties from
franchised restaurants and
royalties from a partnership
with Kraft foods to sell CPK-

8/5/12

The Power of Susan


Collyns

Facilitating success:
Increase advertising
Increase leverage using debt financing

Purchase U.S. Treasury Securities

Change Capital Structure Policy

Repurchase stock option

8/5/12

Effect of Leverage on
ROE

Interest Rate
Tax Rate
Earnings before income taxes and
interest
Interest Expense
Earnings before taxes
Income taxes
Net income

Book value:
Debt
Equity
Total capital

ROE = Net Income/ Shareholder


Equity

8/5/12

Debt/Total Capital
Actual 10%
20% 30%
6.16% 6.16% 6.16% 6.16%
32.50
32.50
32.50%32.50%
%
%
30,054 30,054 30,054 30,054
0 1,391 2,783 4,174
30,054 28,663 27,271 25,880
9,755 9,303 8,852 8,400
20,299 19,359 18,419 17,480

0 22,589 45,178 67,766


203,29 180,71 158,12
225,888
9
0
2
225,88 225,88 225,88
225,888
8
8
8

10.19 11.05
8.99% 9.52%
%
%

Effect of Leverage on Cost


of Capital
CAPM

= bL = bU[1 + (1 T)D/E]

10%
bL = bU [ 1 + ( 1 - 32.5%) 22,589 /
628,516]
bL = 0.85 [ 1 + (0.675) 0.0359]
bL = 0.85 [ 1 + 0.0242]
bL = 0.85 [1.0242]
bL= 0.87057

20%
bL = bU [ 1 + ( 1 - 32.5%) 45,178 /
613,259]
bL = 0.85 [ 1 + (.675) 0.0737]
bL = 0.85 [ 1 +0.0497]
bL = 0.85 [1.0497]
bL= 0.892245

30%
bL = bU [ 1 + ( 1 - 32.5%) 67,766 / 598,002]
bL = 0.85 [ 1 + (0.675) 0.1133]
bL = 0.85 [ 1 + 0.0765]
bL = 0.85 [1.0765]
bL= 0.915025

8/5/12

WACC
Formula:

(kd) (1-t)(%debt-financed)

kd=6.16%

tax shield: 32.5%

ke= capm beta UL

debt financed divided by Total market value

(ke)(%equity-financed)

equity financed divided by total market value

WACC:

kd

10%

20%

30%

6.16%

6.16%

6.16%

tax shield

0.6750

0.6750

0.6750

debt financed

0.0347

0.0686

0.1018

ke

0.095529

0.096612

0.0977513

equity financed

0.9653

0.9314

0.8982

ovr kd

0.001443

0.002852

0.0042328

ovr ke

0.092214

0.089985

0.0878002

WACC

0.093656 0.092837

0.092033

9.20%

9.37%

9.28%

Re = Rf + B[Rm - Rf]

8/5/12

0.095529RE

CPK Share Price

Actual

Debt/Total Capital
10%

20%

30%

Book value:

Debt
Equity
Total capital

22,589

45,178

67,766

225,888

203,299

180,710

158,122

225,888

225,888

225,888

225,888

Market value:

Debt
Equity
Total capital

Number of Shares Outstanding

22,589

45,178

67,766

643,773

628,516

613,259

598,002

643,773

651,105

658,437

665,768

29,130,000 29,130,000 29,130,000 29,130,000

MV Stock Price per Share

22.10 $

21.58 $

21.05 $

20.53

BK Stock Price per Share

7.75 $

6.98 $

6.20 $

5.43

Difference btwn BK & MV

14.35 $

14.60 $

14.85 $

15.10

8/5/12

Stock Price &Total


Capital Structure
Actual

8/5/12

Debt/Total Capital
10%
20%

30%

Book value:
Debt
Equity
Total capital

0
225,888
225,888

22,589
203,299
225,888

45,178
180,710
225,888

67,766
158,122
225,888

Market value:
Debt
Equity
Total capital

0
643,773
643,773

22,589
628,516
651,105

45,178
613,259
658,437

67,766
598,002
665,768

SharePrice
MV- #of Shares Outstanding

$22.10
29,130

$22.10
28,440

$22.10
27,749

$22.10
27,059

Treasury stockRepurchases
Number of Shares Oustanding- Actual
Stock Price per Share
EPS
ROE
Number of Shares Outstanding Less Repurchase1M X $22.10= $22,100,000
Stock Price per Share
EPS
ROE
Number of Shares Outstanding Less Repurchase
to recover 10% decline= 2.65M * $22.10=
$58,565,000
Stock Price per Share
EPS
ROE
Number of Shares Outstanding to Meet Industry
Standards- 9.13 M X $22.10 = $201,773,000
Stock Price per Share
EPS
ROE

8/5/12

29,130,000
29,130,000
$
$
22.10
21.58

$
$
0.70
0.66

8.99%

9.52%

29,130,000 29,130,000
$
$
21.05
20.53
$
$
0.63
0.60
10.19%

11.05%

28,130,000
28,130,000 28,130,000 28,130,000
$
22.89
$
22.34 $
21.80 $
21.26
$
$
$
$
0.72
0.69
0.65
0.62
9.25%

9.84%

26,480,000 26,480,000
$
$
24.31
23.74

$
$
0.77
0.73

9.83%
10.52%

10.57%

11.53%

26,480,000 26,480,000
$
23.16
$
22.58
$
$
0.70
0.66
11.41%
12.60%

20,000,000
20,000,000 20,000,000 20,000,000
32.18865
31.4258
30.66295
29.9001
$
$
$
$
1.01
0.97
0.92
0.87
13.01%
14.51%
16.62%
19.81%

CPK No Longer
Publically Traded

Shares in California Pizza


Kitchen first traded on the
NASDAQ National Market on
August
2, 2000 under the ticker
8/5/12

Interest Tax Deductions

Before Stock Repurchase


Market Price

$22.10

Investor's # of
Shares

$22.10

8/5/12

# of Shares
Outstanding

1,000

After Stock Repurchase


Market Price

Investor's # of
Shares

1,000

29,130,000

# of Shares
Outstanding

28,130,000

EPS

0.70

EPS

0.72

Increased

wealth
to
shareholders

due to stock
repurchase

without
double
taxation.

Recommended Capital
Structure Policy
Repurchase 2.65 million shares of stock

at a cost of $58,565,000

using the 30% debt financing option totaling


$67.7 million

EPS decrease = $.04

ROE increase= 3.61%

Cost of Capital increase= 0.91

8/5/12

Questions?

8/5/12