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CPK I. POINT OF VIEW Susan Collyns, the Chief Financial Officer II.

THE PROBLEM With less cash available, what should California Pizza Kitchen do to repurchase shares in order to increase their share price which is currently in the low 20s? III. OBJECTIVE To choose a financial policy within California Pizza Kitchens existing $75 million line of credit that will enable it to buy back their shares issued to the public. IV. AREAS OF CONSIDERATION
a. California Pizza Kitchen, created by Larry Flax and Rick Rosenfield, has a

conservative financial policy. It has avoided putting any debt to its balance sheet in the view that a strong balance sheet with high equity has a strong staying power.
b. California Pizza Kitchen showed a strong revenue growth despite sharp

declines in customer traffic. However, its share price declined 10% during the month of June, 2007. Its current share price value amounted to $22.10. Such decline led the management team to discuss repurchasing company shares. But with little money in excess of cash (see Exhibit 1), such repurchase program would require debt financing.
c. Interest rates are currently on the rise. The company could take advantage

of the benefits of moderately levering up its equity.

V. ALTERNATIVE COURSES OF ACTION


1. Leverage California Pizza Kitchens balance sheet with ten percent (10%)

debt/borrowings having an interest rate of 6.16%.

Advantage(s): Leveraging California Pizza Kitchens balance sheet presents two benefits. First, interest payments are tax deductible. The company can enjoy the benefit of tax shield each year and its corporate income tax liability, which amounted to $9,012 (see Exhibit 1) as of July 1, 2077, will be reduced. With the total capital leveraged with ten percent (10%) borrowings or debt amounting to $22,589, the company will enjoy a tax shield of $452 (see Exhibit 4). Second, the market value of capital will increase from the actual value of $643,773 to $651,105 (see Exhibit 2). Financing ten percent (10%) of the total capital increases the total cash available for use and thus enables the company to repurchase their stocks issued to the public. Financing the companys capital with 10% borrowings is considered as the most conservative choice among the other alternatives mentioned below.

Disadvantage(s): Though the company will be able to enjoy the tax shield provided by financing ten percent (10%) of the total capital, the new debt increases the expenses of the company by $1,391, which is 6.16% of the new debt amounting to $22,589. Also, an increase in the expenses decreases the net income of the company (see Exhibit 3).

2. Leverage California Pizza Kitchens balance sheet with twenty percent (20%) debt/borrowings with the same interest rate.

Advantage(s): Financing twenty percent (20%) of the total capital through debt enables the company to benefit in tax shield amounting to $904 (see Exhibit 4). It also increases the market value of capital from $643,773 to $658,437 (see Exhibit 2). This is $14,664 higher than the actual market value and $7,332 higher than the market value presented in the first alternative. In this alternative, the company will be able to repurchase more number of shares as compared to the first alternative. The company will still be able to earn from their operations and at the same time introduce debt into their financial statement.

Disadvantage(s): Same with the previous option, financing twenty percent (20%) of the total capital increases the expenses of the company by $2,783, which is 6.16% of the new debt amounting to $45,178.

3. Leverage California Pizza Kitchens balance sheet with twenty percent (30%) debt/borrowings with the same interest rate.

Advantage(s): Financing thirty percent (30%) of the total capital through debt enables the company to benefit in tax shield amounting to $1,356 (see Exhibit 4). It also increases the market value of capital from $643,773 to $665,769 (see Exhibit 2). This is $21,996 higher than the actual market value and is considered as the recapitalization scenario having the highest market value among the previous two alternatives.

Disadvantage(s): A company considered highly leveraged may find its freedom of action restricted by its creditors and/or may have its profitability hurt as a result of paying high interest costs. In this alternative, financing thirty percent (30%) of the total capital may not affect the companys financial position in the short run. But, in the long run, its financial position may be affected especially if the interest costs prove to be difficult to pay back due to external factors (i.e. inflation) which may happen in the future.

VI. RECOMMENDATION / CONCLUSION A company's reasonable and proportional use of debt and equity to support its assets is a key indicator of balance sheet strength. A healthy capital structure that reflects a low level of debt and a corresponding high level of equity is a very positive sign of investment quality. In this regard, the second alternative course of action is recommended. The company need only to repurchase their stocks and refinancing with twenty percent (20%) debt is enough for that purpose. The company may also use the excess amount in other ventures such as strengthening their brand and innovating new products. Though the thirty percent (30%) debt financing is still within the bounds of the companys existing $75 million line of credit and it gives higher tax shield compared to the second alternative, there is a possibility that the company may exceed that line of credit considering its possible increase in the reliance on debt financing.