California Pizza Kitchen Case Study

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Our reasoning behind this decision involves multiple factors. In addition to higher EPS, Cost of Equity and WACC are not too high, and not too low relative to the other financing options. As more debt is issued, both Cost of Equity and WACC increase and create more risk. As companies take on more leverage, they’re limited in their financial flexibility by creditors which is one of the reasons we found the 20% debt capacity more attractive than the 30% debt capacity. One thing to note is that our cost of equity and WACC both decreased with 20% debt because of the tax shield provided by debt and our use of CAPM when computing cost of equity, which differs from the method used in the table. We feel that with current management and continued strong earnings that CPK can sufficiently maintain a debt level of 20% Debt/ Total Book Capital, without having a large impact on their margins. Although the earnings of the company with decrease from $.70 with no debt/total book capital to $.68 with 20% debt/total book capital, we believe this small drop off in earnings is necessary as it increases shareholder value while also allowing growth of the firm given the struggling food commodity price environment. While the EPS of the shares will drop from $.70 to $.68, we find that shareholders would approve of this issuance of debt as it allows for the share price to increase, ultimately increasing the P/E ratio of the firm showing stronger growth on a long-term basis.