California Pizza Kitchen Case Study

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For CPK’s finance team, there are couple decisions which were needed to make. The Chef Financial Officer Susan Collyns has two issues to solve the capital expenditures. In CPK’s 2007 growth plan, it has sixteen to eighteen new locations are in need to open. And the funding requires $85 million in capital expenditure. To realize the development in expansion, Collyn needs to solve this problem by changing capital structure. Then she needs to repurchase its shares at the price of $22.10. She needs to decide whether or not to buy back shares and leverage the balance sheet, and how much debt should the company take on.

Though CPK is growing quickly in contrast with other competition restaurants, its stock price has declined by 10%. Collyns should raise the stock price by repurchasing shares and leverage the balance sheet. If CPK takes on debt, its beta will go up, and the stock price will also be raised. When company were levering up and repurchasing shares, it can increase earnings per share in result of tax shield. It can lower the cost of issuing debt. Then we can use debt to repurchase outstanding shares. And after that the earnings per share will increase. It can finally add value to the company. And leveraging will increase ROE in similar way as issuing debt did. The return on equity will rise when the company takes on debt. And it will keep increasing if the company takes on more and more debt to become more leveraged. Then the earnings are spread over a reduced amount of equity. So, the share price of the company goes up. At the time that company make an increment on its leverage, which means purchasing back shares. The equity is reduced at the same time. In the end, it will make the share price go up.

If Collyns were to choose not do the recapitalization, the company would be traditionally conservative and it will be debt free. Since 2000, it started to use the proceeds from its initial public offering to pay off its outstanding debt. The company was able to totally avoid debt financing. CPK is now planning to strongly expand its business by expanding geographically. So it needs a large amount of expenditures to afford its expansion. If CPK does not go leverage, it would not be able to pay for its expenditures.

My recommendation for CPK is choose to repurchase outstanding shares and leverage the balance sheet. While, the company should pay attention to the risks come with recapitalization. Cause the recapitalization will weaken their staying power. As the increase of debt to equity ratio, they also will increase their risk of default. If do it in a proper way, the value of the company will be increased.