Brief history of CPK (p.3) Reasons for CPKs success (p.3) Ways to facilitate the success of CPK (p.3-4) Anticipated effect of changing the capital structure on return on equity (p.4) Anticipated effect of changing the capital structure on cost of capital (p.5) Expected number of shares of CPK that can be repurchased (p.6-7) Anticipated effect of changing the capital structure on CPKs stock price (p.6-7) Our recommendation (p.7) In order to explore whether or not California Pizza Kitchen should change their capital structure, we must first look at the brief history of the firm to get a better idea of the corporate culture and the firms appetite for risk. California Pizza Kitchen started in 1985 and they have been rather successful given*…show more content…*

As we see in Exhibit B in the appendix, with an increase of 10, 20, and 30 debt to total capital, we see our ROE increase to 9.52, 10.19, and 11.05 respectively. However this increase in ROE comes at a price, as the overall risk of the company is increased with the addition of the debt obligations. In Exhibit B, we see that the beta of equity increase as we increase our debt in the capital structure, and increasing beta indicates increased systematic risk for the firm. This increase in beta is also a factor that contributes to the increased cost of equity. As shown in Exhibit B, the cost of equity increases 21 bps with the addition of 10 debt, 43 bps with the addition of 20 debt, and 67 bps with the addition of 30 debt into the capital structure. The increased basis points come as investors will begin to demand a higher rate of return on their investment as more debt is added to the structure because, as residual claimants, their claim to assets are reduced in favor of the bond holders. This increased rate will make it more difficult to raise future capital in the equity market if needed. However, by issuing debt which has a lower cost of capital at 6.16 and repurchasing equity that has a cost of capital of 13.37 (unlevered), the company can reduce its overall cost of capital, or the weighted average cost of capital (WACC). The WACC is measured by taking the weight of debt

As we see in Exhibit B in the appendix, with an increase of 10, 20, and 30 debt to total capital, we see our ROE increase to 9.52, 10.19, and 11.05 respectively. However this increase in ROE comes at a price, as the overall risk of the company is increased with the addition of the debt obligations. In Exhibit B, we see that the beta of equity increase as we increase our debt in the capital structure, and increasing beta indicates increased systematic risk for the firm. This increase in beta is also a factor that contributes to the increased cost of equity. As shown in Exhibit B, the cost of equity increases 21 bps with the addition of 10 debt, 43 bps with the addition of 20 debt, and 67 bps with the addition of 30 debt into the capital structure. The increased basis points come as investors will begin to demand a higher rate of return on their investment as more debt is added to the structure because, as residual claimants, their claim to assets are reduced in favor of the bond holders. This increased rate will make it more difficult to raise future capital in the equity market if needed. However, by issuing debt which has a lower cost of capital at 6.16 and repurchasing equity that has a cost of capital of 13.37 (unlevered), the company can reduce its overall cost of capital, or the weighted average cost of capital (WACC). The WACC is measured by taking the weight of debt

Related

- Decent Essays
## Capital Structure: History of Leverage at Harvey Norman

- 894 Words
- 4 Pages

The statement of cash flows outlines some of the changes to the capital structure. The company added $164.5 million in a consolidated loan facility, and it paid out $138.1 million in dividends. There were no share buybacks during the year. The company states in the annual report (p.4) that it intends to maintain a conservative gearing ratio. The company in this section attributes its increased borrowings to projects and opportunities on which it has embarked. These investments lie within the integrated retail, franchise and property system. One of the

- 894 Words
- 4 Pages

Decent Essays - Better Essays
## MW PETROLEUM Essay

- 1321 Words
- 6 Pages

At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable

- 1321 Words
- 6 Pages

Better Essays - Decent Essays
## Case Report for Midland Energy Resources, Inc: Cost of Capital

- 1187 Words
- 5 Pages

To relever the βe, we use the formula, βe = βu +(D/E)*(βu-βd). And the “Target D/E” was found by taking “Target D/V” divided by “1-Target D/V”. So we get the new βe, 1.3576. Then to get cost of equity, we use the CAPM formula, Re=Rf+β(EMRP), 11.7679%. Since we have get the cost of equity and cost of debt, we can determined the WACC, which is equal to Equity/Value*Cost of Equity+Debt/Value*Cost of Debt*(1-tax rate). In the end ,we arrived at 8.48%.

- 1187 Words
- 5 Pages

Decent Essays - Good Essays
## Essay on Finance 100 - Hydrotech Case Study

- 835 Words
- 4 Pages

Weight of Equity = 71%; Equity Cost of Capital = 12%; Weight of Debt = 29%; Debt Cost of Capital = 4.55%

- 835 Words
- 4 Pages

Good Essays - Decent Essays
## Project Finance

- 1543 Words
- 7 Pages

On the other hand, more debt does not affect the risk of the project under taken, but means less equity holders , these bring more risk to equity holders, the cost of equity increases with debt. assume Ra is the WACC without leverage.

- 1543 Words
- 7 Pages

Decent Essays - Best Essays
## Google Capital Structure Analysis Essay

- 2081 Words
- 9 Pages

The course project involved developing a great depth of knowledge in analyzing capital structure, theories behind it, and its risks and issues. Before I began this assignment, I knew nothing but a few things about capital structure from previous unit weeks; however, it was not until this course’s final project that came along with opening

- 2081 Words
- 9 Pages

Best Essays - Better Essays
## FIN515 Second Course Project

- 1093 Words
- 5 Pages

While the relative debt and equity values can be easily determined, calculating the costs of debt and equity can be problematic. In calculating each component, we are given many different options and proxy values (boundless.com, 2015). In addition the calculation is based on assumptions of the capital mix that cannot always be maintained, “One of main limitation of using WACC is that it does not take into consideration the floatation cost of raising the marginal capital for new projects. Another problem with WACC is that it is based on an impractical assumption of same capital mix which is very difficult to maintain” (Borad, 2012).

- 1093 Words
- 5 Pages

Better Essays - Better Essays
## Mercury Athletic: Valuing the Opportunity Essay examples

- 1035 Words
- 5 Pages

If the leverage increases from expected level, D/C will increase, the levered beta will increase, the cost of equity will increase, the after-tax cost of debt will keep the same. In addition, the weight of the after-tax cost of debt will increase and the weight of the cost of equity will decrease. It looks like that it is difficult to determine how WACC will change. However, according to the Figure 3-8 about the effects of capital structure in Chapter 15, we can find that when the debt ratio is 40%, WACC reaches the minimum value, so in this case, when the leverage change from 20% to 40%, WACC will decrease, and when the leverage bigger than 40%, WACC will increase.

- 1035 Words
- 5 Pages

Better Essays - Better Essays
## Optimum Capital Structure Of Costco Sale

- 1668 Words
- 7 Pages

The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).

- 1668 Words
- 7 Pages

Better Essays - Better Essays
## Midland Energy Resources, Inc.

- 1205 Words
- 5 Pages

Cost of Equity is the return that stockholders require for a company. A company’s cost of equity represents the compensation that the market demands in exchange for owning the assets and bearing the risk of ownership. Based on capital markets the cost of equity varies in direct relation to the assumed risk in that specific market. The distinctive of the firm is the sensitivity to market risk (β) which depends on everything from management to its business and capital structure. Therefore past performances and present conditions have a direct effect on the overall value. Applying calculations at a divisional level allows specified markets to be analysis based on present market conditions for that service or product. The formula used to calculate Cost of Equity is:

- 1205 Words
- 5 Pages

Better Essays - Decent Essays
## Red Hen Case Study

- 1235 Words
- 5 Pages

Our analysis attempts to answer the question, “What are the things a company must consider when analyzing a new investment or project?” According to the text, a firm’s first objective when deciding to take on new debt should be that its return on net assets (RONA) should be greater than its weighted average cost of capital (WACC). Since we are working with an income statement only and do not have an amount for net assets, we will instead use return on invested capital (ROIC), which measures how well a company is using its money to generate returns. Comparing a company 's return on capital (ROIC) with its cost of capital (WACC) reveals whether invested capital was used effectively. From our spreadsheet calculations we see that using our estimated operating profit provides us with a 19.9% return on invested capital with only a 7.2% weighted average cost for that same capital. If these numbers are even close to correct, George should definitely make the move.

- 1235 Words
- 5 Pages

Decent Essays - Decent Essays
## Star Appliances B

- 1181 Words
- 5 Pages

Given that the cost of equity is 9.4% and the cost of debt is 12.2%, Star’s cost of capital can be calculated as 9.14% (Appendix B). The company was also considering raising the cost of debt to the industry average of 19%. At this cost of debt, Star Company would have a lower cost of capital of 8.24% (Appendix B) because interest on debt capital is deductible whereas dividend payments on equity capital are not.

- 1181 Words
- 5 Pages

Decent Essays - Better Essays
## Wrigley Jr. Company

- 1520 Words
- 7 Pages

Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that

- 1520 Words
- 7 Pages

Better Essays - Better Essays
## Case Study: Marriot Corporation : the Cost of Capital. Essay

- 994 Words
- 4 Pages

To estimate the cost of equity, we need to compute the beta of equity for each division using comparable companies. As the betas of debt were not provided, we made 2 assumptions: a. same business lines have the same beta of debt; b. Expected return of debt = Rf + βb*[E(Rm) – Rf*(1-T)] (Rf: risk free rate, E(Rm): expected

- 994 Words
- 4 Pages

Better Essays - Better Essays
## Corporate Tax, Cost of Debt, Cost of Equity and Capital Structure: a Case Study of Reits and Conventional Real Estate Firms in the Uk

- 8383 Words
- 34 Pages

Already in 1958, Modigliani and Miller have pointed the discussion of capital structure towards the cost of debt and equity. According to their first proposition, in a world of no corporate taxes and with perfect markets, financial leverage has no effect on a firm’s value. In their second proposition, they state that the cost of equity equals a linear function defined by the required return on assets and the cost of debt (Modigliani and Miller, 1958).

- 8383 Words
- 34 Pages

Better Essays