Summery of California Pizza Kitchen case

Summary: California Pizza Kitchen The California Pizza Kitchen was founded by Larry Flax and Rick Rosenfield in 1985. CFK operates a casual dining chain which mostly focuses on pizza segment. It is well renowned for barbecue chicken pizza as well as the designer pizza. By the end of 2007, the company had 213 restaurants in 28 states and 6 in foreign countries. But the real financial condition of CFK was severely  problematic. The company’s share price declined at the rate of 10% making a current value of $22.10. For the fact, the company decided to buy back the shares. But the company current cash and cash equivalents are only 2.11% to its total cash. Hence the company has no potential to buy back the shares. But the company had no debt so they had the strong potential of borrowing debt but the interest rates were not in the favor of the CPK, so due to this fact the company was hesitating to take the loan. There are three principal situations lead to stock repurchases. A company may decide to increase its leverage by issuing debt and using the proceeds to repurchase stock. Secondly, many firms have given their employees stock options, and they repurchase stock for use when employees exercise the options. Thirdly, a company may have excess cash. But with CFK the only option is to increase its leverage by issuing debt and from that it should repurchase the stocks. To find out that whether it will be beneficial for the company issue debt or not we have to go through finding out the ROE for the company. ROE is useful for comparing the profitability of a company to that of other firms in the same industry. We have to calculate ROE on the basis of  actual, 10%, 20% and 30%. By calculation we can see that interest expense is increase and the earnings are decreasing. Because for paying back the debt the interest should be paid, this will increase the interest expense by decreasing the net earning. Secondly, calculate the CAPM the more the CAPM the more the business risk. After calculating the CAPM at rate of 10% 20% and 30% we get the following figures for CAPM i.e. 0.871 at 10%, 0.042 at 20% and 0.065 at 30%. So the low CAPM is at 20%. So, it is more favorable for the company to go for 20%. But as we found the WACC, it was found that WACC is decreasing with increase in interest rate because the cost of capital is increasing. But it will be good for the company to go for 30% because at this rate the debt amount is higher. The higher debt will decrease the price of stock to $20 dollars. So it will be beneficial for the company to repurchase the stocks at this rate.