Midterm Case CALIFORNIA PIZZA KITCHEN
Synopsis and Objectives
This case examines the question of financial leverage at California Pizza Kitchen (CPK) in July 2007. With a highly profitable business and an aversion to debt, CPK management is considering a debt- financed stock buyback program. The case is intended to provide an introduction to the Modigliani- Miller capital structure irrelevance propositions and the concept of debt tax shields. With the background of a pizza company, the case provides an engaging context to discuss the “pizza graphs” that are commonly used in corporate finance curriculum to illustrate the wealth effects of capital structure decisions.
The case serves the following learning outcomes:
D. Assess the variables the finance manager should consider when determining the firm capital structure.
E. Analyze the effects of financial leverage on the firm’s cost of capital and value.
Questions
1. What is going on at CPK? What decisions does Susan Collyns face? In what ways can she facilitate the success of CPK? (3 Marks) (CLOD)
2. Using the scenarios in case Exhibit 9, what role does leverage play in affecting the return on equity (ROE) for CPK? How does debt add value to CPK? (3 Marks) (CLOE)
3. What is the ratio of debt-to-equity that maximizes the shareholder’s value? Why should the stockholders care about maximizing firm value? Shouldn’t they be interested in strategies that maximize shareholder value only? (3 Marks) (LOE)
4. Is the capital structure decisions relevant for maximizing the shareholders’ value? What are the key drivers for increasing value of CPK how it affects its capital providers i.e. shareholders and creditors. What is the case for not doing the recapitalization? (3 Marks) (LOD)
5. What should Collyns recommend? (3 Marks) (LOE)
6. Prepare a PowerPoint presentation to discuss and justify all your assumptions and
recommendations (5 Marks) (LOE). Please refer to the relevant rubric. -2-
CASE 33
Please note that for the midterm exam, the case No. 33, California Pizza Kitchen has been assigned to you for individual case write-up report and presentation.
The case report write-up and presentation will have 20% weight for the total grade of the course.
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