California Pizza Kitchen

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Step two is to determine what the company has to gain from adding leverage to its balance sheet. The one advantage mentioned in the case would be to reduce their corporate income-tax liability. Since the company would be using debt to repurchase shares and not increase asset it does not increase the total capital, but instead increases the debt while decreasing it equity. This in turn lowers the company’s income tax, which can been seen in exhibit 9.

Step three is to evaluate the affects of a repurchase program. Should the company used leverage to repurchase share and if so how much? On the surface level, putting into affect a repurchase program would signal to investors that the company’s stock price may be under valued as management is willing to buy back stock at its current price. This would have a positive effect on investors as they may see this as an opportunity to purchased share of a good company’s whose stock may be undervalued, thus ultimately increasing the stocks price. Now that we’ve determine what benefits a repurchase program will serve to the company, we should determine how much debt should be used and how many shares should be repurchased. So at the given debt ratios, 10%, 20%, 30%, the BV of debt used are $22,589 K, $45178 K, and $67,766 K respectively. The amounts repurchased turned out to be 1,011 K, 1,999 K, and 2,965 K. It is important to note that even at 30% debt the company remained under its 75 million dollar line of credit.

After reviewing the financial statement, my final recommendation would be to borrow 20% of debt to repurchase 1,999 thousand shares. Reason being borrowing that about would align their ROE with fiscal year 2006. Although 30% would increase it ROE even more, it is important to not that this would be an artificial increase and not really weigh as much in the minds of investors and shareholders.