60.1K

Verified Solution

Link Copied!

QUESTIONS FOR CASE STUDY CALIFORNIA PIZZA KITCHEN

2. Using the scenarios in case Exhibit 9, what role does leverage play in affecting the return on equity (ROE) for CPK? What about the cost of capital? In assessing the effect of leverage on the cost of capital, you may assume that a firms CAPM beta can be modeled in the following manner: L = U[1 + (1 T)D/E], where U is the firms beta without leverage, T is the corporate income tax rate, D is the market value of debt, and E is the market value of equity.

Case 33 California Pizza Kitchen 465 EXHIBIT 9 Pro Forma Tax Shield Effect of Recapitalization Scenarios (dollars in thousands, except share data; figures based on end of June 2007) Debt/Total Capital Actual 10% 20% 30% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% Interest rate Tax rate Earnings before income taxes and interest Interest expense Earnings before taxes Income taxes 30,054 0 30,054 9,755 20,299 30,054 1,391 28,663 9,303 19,359 30,054 2,783 27,271 8,852 18,419 30,054 4,174 25,880 8,400 17,480 Net income 0 225,888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 Book value: Debt Equity Total capital Market value: Debt? Equity Market value of capital 0 643,773 643,773 22,589 628,516 651,105 45, 178 613,259 658,437 67,766 598,002 665,769 Notes: 'Interest rate of CPK's credit facility with Bank of America: LIBOR + 0.80%. 2 Earnings before interest and taxes (EBIT) include interest income. 3 Market values of debt equal book values. 4 Actual market value of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million). Source: Case writer analysis based on CPK financial data

Answer & Explanation Solved by verified expert

See Answer