California Pizza Kitchen Case Study Solution

The company can save its tax expenses by a certain percentage.Inclusion of 10% debt in its capital structure would result in increase in the company’s return on equity by 1%. Increase in ROE indicates the efficiency of the company. However, debt to assets ratio of the company would be 10%, which indicates that the company’s capital structure is composed of 10% debt and 90% equity. By leveraging 10%, the company’s value would also improve. By taking 10% debt, the company would be able to repurchase its share from the market. The number of shares that the company would repurchase from the market by using 10% of debt would be 1011. Although, by debt financing the earning per share of the company would be reduced, but it would improve the price per share, which is the ultimate goal of the company. Additionally by including debt financing in capital structure, the levered beta of the company would increase to .87.However, WACC of the company would be reduced to 8.92%. By including 10% debt in the capital structure the company would improve its efficiency by improving return on equity, price per share and reducing WACC.

Alternative-3: 20% Debt

Another alternative for the company is to finance the capital structure by 20% debt. By increasing debt participation in the capital structure; the company would be able to repurchase its share its share from the market. The number of share that the company would repurchase from the market by using 20% debt would be 1999. Although, increase in debt financing would also improve the levered beta of the company, but would reduce WACC and improve the value of the firm. Additionally, by increasing the debt in its capital structure, earning per share would reduce and the company would be able to enjoy more tax shield.

Alternatiove-4: 30% Debt

Another alternative of the company is to increase the debt participation in its capital structure by 30%. Increase in debt would also increase the leverage of the company and enable the company to repurchase its share from the market in order to improve its market price. Additionally, increasing the debt level would also reduce the WACC of the company, which is considered to be a positive sign. However, by using the debt, the company would be able to repurchase 2965 number of share and save up to 21996 in term of tax shield.

Conclusion

As per the calculations and evaluations, it is recommend that the company should choose alternative-4 (30% debt) and borrow money in order to improve all the aspects of the company. It will improve the earning per share, ROE and also provide tax shield. The company is benefiting a lot by borrowing money than sticking to a non-debt financed company. The debt should be lower than the equity or else it would result in loss.The company should be attentive in borrowing money, and debt financing should be implemented for the growth of the company as well as to improve the share price of the company.

Appendices

Appendix-1: Calculations

Appendix-2: WACC

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