California Pizza Kitchen Case Study on Capital Structure/Leveraging Debt

1936 Words Jul 18th, 2013 8 Pages
A company's capital structure is a very important component of a company's financial health and longevity. The capital structure should maximize total net profit and overall shareholder wealth. An optimal proportion of equity and debt as a company's capital structure is an indication of a well-managed and successful company and should be a goal for most corporations.
Beverly Flax and Rick Rosenfield founded California Pizza Kitchen (CPK) in 1985 in Beverly Hills, California. It is a casual dining, full service restaurant concept that specializes in gourmet pizzas with unique topping combinations. They operated 213 locations in 28 states and 6 foreign countries by the end of the second quarter of 2007. Almost all of the firms revenue
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Figure 1. California Pizza Kitchen Valuation Analysis
(Millions of Dollars Except Per Share Data) Input Data (Millions Except Per Share Data)
Tax rate 32.50%
Debt (D) $0.00
Number of shares (n) 29.13
Stock price per share (P) $22.10
NOPAT $30.05
Free Cash Flow (FCF) $27.59
Growth rate in FCF 5.00% Capital Structure (Millions Except Per Share Data)
Market value of equity (S = P ´ n) $643.77
Total value (V = D + S) $643.77
Percent financed with debt (wd = D/V) 0%
Percent financed with stock (ws = S/V) 100% Cost of Capital
Cost of debt (rd) 6.16%
Beta (b) 1.50
Risk-free rate (rRF) 2.00%
Market risk premium (RPM) 5.00%
Cost of equity (rs = rRF + b ´ RPM ) 9.50%
WACC 9.50% Intrinsic Valuation (Millions Except Per Share Data) Value of operations:
Vop = [FCF(1+g)]/(WACC−g) $643.77
+ Value of ST investment $0.00
Total intrinsic value of firm $643.77
− Debt $0.00
Intrinsic value of equity $643.77
÷ Number of shares 29.13
Intrinsic price per share $22.10

Figure 2. Estimating California Pizza Kitchen’s Optimal Capital Structure (Millions of Dollars) Percent of Firm Financed with Debt (wd) 0% 10% 20% 30% 40% 50% 1. ws 100.00% 90.00% 80.00%