within Capital Structure Theory: A Current Perspective 2. Utilizing case data from Figure 9 answer the following questions a. If CPK's Debt/Total Equity Capital Ratio was 10%; i. What would be CPK's Return on Equity? ii. What would be CPK's WACC? b. If CPK's Debt/Total Equity Capital Ratio was 20%; i. What would be CPK's Retum on Equity? ii. What would be CPK's WACC? If CPK's Debt/Total Equity Capital Ratio was 30%; i. What would be CPK's Retum on Equity? ii. What would be CPK'S WACC? Debt/Total Capital 20% Actual 10% 30% (1) Interest rate Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% Earnings before income taxes and interest(2) Interest expense Earnings before taxes Income taxes Net income 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 Book value: Debt Equity Total capital 0 225.888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 0 Market value: Debt Equity Market value of capital 643,773 643,773 22,589 628,516 651,105 45,178 613,259 658,437 67,766 598,002 665,769 (2) Notes: Interest rate of CPK's credit facility with Bank of America: LIBOR + 0.80%. EBIT includes interest income. Market values of debt equal book values. Actual market values of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million). 3) (4) Source: Case writer analysis based on CPK financial data. Case Study Assumptions: 1. This case introduces the Modigiani-Miller capital structure irrelevance propositions and the concept of debt tax shields. 2. To calculate CPK's WACC utilize the CAPM model 3. CPK's Beta can be modeled using the following formula: a. BL - BU[1 + (1 -T)D/E] i. BL - CPK's Beta with leverage ii. BU = CPK's Beta without leverage iii. T = Corporate Tax Rate iv. D-Market value of Debt v. E] =Market value of Equity 4. Beta will need to be adjusted to account for the difference between actual and target debt ratio by unlevering beta to determine an unlevered asset beta and levering beta at the target debt rate. As of 12/31/06 1/1/06 7/1/07 s 8,187 $ 7,178 Assets Current assets Cash and cash equivalents Investments in marketable securities Other receivables Inventories Current deferred tax assct, net Prepaid income tax Other prepaid expenses & other current assets Total current assets 11,272 $ 11,408 4,109 3,776 8,437 1,428 5,492 45,922 7,876 4,745 11,721 10,709 4,596 11,834 8,769 6,444 49,530 5,388 37,917 Property and equipment, net Noncurrent deferred tax asset, net Goodwill and other intangibles Other assets Total assets 213,408 255,382 271,867 4,513 5,867 6,328 5,967 5,825 5,754 4,444 5,522 6,300 $274,254 S 310,513 339,779 s Liabilities and Shareholders' Equity Current liabilities Accounts payable Accrued compensation and benefits Accrued rent Deferred rent credits Other accrued liabilities Accrued income tax Total current liabilities 7,054 S 13,068 13,253 4,056 9,294 15,044 S 15,042 14,532 4,494 13,275 3,614 66,001 14,115 15,572 14,979 5,135 13,980 9,012 72,793 46,725 Other liabilities Deferred rent credits, net of current portion 5,383 24,810 8,683 27,486 8,662 32,436 Shareholders' equity: Common stock Additional paid-in-capital Accumulated deficit Accumulated comprehensive loss Total shareholders' equity 197 231,159 (34,013) 193 221,163 (13,013) 291 228,647 (3,050) 197,336 208,343 225,888 Total liabilities & Shareholders' Equity $ 274,254 $310,513 $339,779 Exhibit 7 California Pizza Kitchen, Inc. Comparative Restaurant Financial Data, 2006 Fiscal Year (in millions, except per-share data) Fiscal Year End 7/2/07 Month Share Price EBITDA Margin Revenue Net Profit Earnings Dividends Book Value Margin Per Share Per Share Per Share 3.8% $ 0.71 $ 0.00 $ 7.20 Beta California Pizza Kitchen Doc. $ 22.10 $ 555 10.7% 0.85 Doc. 15.9% 9.6% 12.0% 1.17 0.41 6.49 7.78 0.80 1.05 Doc. June Doc. Doc. 0.90 1.49 0.93 0.20 0.00 0.20 0.00 0.00 1,338 239 4,151 278 1,315 823 5,721 291 1.10 1.02 8.59 6.61 9.09 14.56 13.3% 12.2% 13.0% 13.2% 31.6% 1.00 0.00 1.28 2.16 NA 1.00 0.40 8.37 1.78 0.44 19.84 0.60 Applebee's International, Inc. BJ's Restaurants, Inc. Brinker International Buffalo Wild Wings, Incorporated The Cheesecake Factory, Inc. Chipotle Mexican Grill, Inc. Darden Restaurants, Inc. (2) Frisch's Restaurants, Inc. McCormick & Schmick's Panera Bread Company P.F. Chang's China Bistro (3) RARE Hospitality International Inc. Red Robin Gourmet Burgers Ruth's Chris Steak House, Inc. Sonic Corporation Texas Roadhouse, Inc. 24.28 20.05 29.37 41.78 24.57 86.00 44.14 30.54 25.66 46.02 35.37 26.76 40.19 16.80 22.00 12.81 6.5% 4.1% 4.7% 5.8% 6.2% 5.0% 5.9% 3.1% 4.3% 7.2% 3.6% 5.1% 4.9% 8.7% 11.4% 5.7% 308 0.92 Doc. May May Doc. Doc. Doc. Doc. Doc. Doc. 0.00 1.10 11.20 12.53 829 1.87 0.00 1.25 9.7% 16.3% 10.5% 11.6% 938 1.24 0.00 11.41 1.10 1.45 0.00 11.17 0.57 987 619 1.82 0.00 14.68 2.93 1.05 NA 1.01 0.00 13.7% 15.6% 24.9% 12.5% 272 693 597 Aug. 0.88 0.00 4.66 4.30 0.90 0.90 Dec. 0.44 0.00 Current Assets Current Liabilities Total Debt Shr. Equity Debt! Interest T. Capital Capital Coverage Turnover Return On Capital Equity California Pizza Kitchen 38 $ 66 $ 0 $ 208 0.0% NMF 2.7 10.1% 10.1% within Capital Structure Theory: A Current Perspective 2. Utilizing case data from Figure 9 answer the following questions a. If CPK's Debt/Total Equity Capital Ratio was 10%; i. What would be CPK's Return on Equity? ii. What would be CPK's WACC? b. If CPK's Debt/Total Equity Capital Ratio was 20%; i. What would be CPK's Retum on Equity? ii. What would be CPK's WACC? If CPK's Debt/Total Equity Capital Ratio was 30%; i. What would be CPK's Retum on Equity? ii. What would be CPK'S WACC? Debt/Total Capital 20% Actual 10% 30% (1) Interest rate Tax rate 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% 6.16% 32.5% Earnings before income taxes and interest(2) Interest expense Earnings before taxes Income taxes Net income 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 Book value: Debt Equity Total capital 0 225.888 225,888 22,589 203,299 225,888 45,178 180,710 225,888 67,766 158,122 225,888 0 Market value: Debt Equity Market value of capital 643,773 643,773 22,589 628,516 651,105 45,178 613,259 658,437 67,766 598,002 665,769 (2) Notes: Interest rate of CPK's credit facility with Bank of America: LIBOR + 0.80%. EBIT includes interest income. Market values of debt equal book values. Actual market values of equity equals the share price ($22.10) multiplied by the current number of shares outstanding (29.13 million). 3) (4) Source: Case writer analysis based on CPK financial data. Case Study Assumptions: 1. This case introduces the Modigiani-Miller capital structure irrelevance propositions and the concept of debt tax shields. 2. To calculate CPK's WACC utilize the CAPM model 3. CPK's Beta can be modeled using the following formula: a. BL - BU[1 + (1 -T)D/E] i. BL - CPK's Beta with leverage ii. BU = CPK's Beta without leverage iii. T = Corporate Tax Rate iv. D-Market value of Debt v. E] =Market value of Equity 4. Beta will need to be adjusted to account for the difference between actual and target debt ratio by unlevering beta to determine an unlevered asset beta and levering beta at the target debt rate. As of 12/31/06 1/1/06 7/1/07 s 8,187 $ 7,178 Assets Current assets Cash and cash equivalents Investments in marketable securities Other receivables Inventories Current deferred tax assct, net Prepaid income tax Other prepaid expenses & other current assets Total current assets 11,272 $ 11,408 4,109 3,776 8,437 1,428 5,492 45,922 7,876 4,745 11,721 10,709 4,596 11,834 8,769 6,444 49,530 5,388 37,917 Property and equipment, net Noncurrent deferred tax asset, net Goodwill and other intangibles Other assets Total assets 213,408 255,382 271,867 4,513 5,867 6,328 5,967 5,825 5,754 4,444 5,522 6,300 $274,254 S 310,513 339,779 s Liabilities and Shareholders' Equity Current liabilities Accounts payable Accrued compensation and benefits Accrued rent Deferred rent credits Other accrued liabilities Accrued income tax Total current liabilities 7,054 S 13,068 13,253 4,056 9,294 15,044 S 15,042 14,532 4,494 13,275 3,614 66,001 14,115 15,572 14,979 5,135 13,980 9,012 72,793 46,725 Other liabilities Deferred rent credits, net of current portion 5,383 24,810 8,683 27,486 8,662 32,436 Shareholders' equity: Common stock Additional paid-in-capital Accumulated deficit Accumulated comprehensive loss Total shareholders' equity 197 231,159 (34,013) 193 221,163 (13,013) 291 228,647 (3,050) 197,336 208,343 225,888 Total liabilities & Shareholders' Equity $ 274,254 $310,513 $339,779 Exhibit 7 California Pizza Kitchen, Inc. Comparative Restaurant Financial Data, 2006 Fiscal Year (in millions, except per-share data) Fiscal Year End 7/2/07 Month Share Price EBITDA Margin Revenue Net Profit Earnings Dividends Book Value Margin Per Share Per Share Per Share 3.8% $ 0.71 $ 0.00 $ 7.20 Beta California Pizza Kitchen Doc. $ 22.10 $ 555 10.7% 0.85 Doc. 15.9% 9.6% 12.0% 1.17 0.41 6.49 7.78 0.80 1.05 Doc. June Doc. Doc. 0.90 1.49 0.93 0.20 0.00 0.20 0.00 0.00 1,338 239 4,151 278 1,315 823 5,721 291 1.10 1.02 8.59 6.61 9.09 14.56 13.3% 12.2% 13.0% 13.2% 31.6% 1.00 0.00 1.28 2.16 NA 1.00 0.40 8.37 1.78 0.44 19.84 0.60 Applebee's International, Inc. BJ's Restaurants, Inc. Brinker International Buffalo Wild Wings, Incorporated The Cheesecake Factory, Inc. Chipotle Mexican Grill, Inc. Darden Restaurants, Inc. (2) Frisch's Restaurants, Inc. McCormick & Schmick's Panera Bread Company P.F. Chang's China Bistro (3) RARE Hospitality International Inc. Red Robin Gourmet Burgers Ruth's Chris Steak House, Inc. Sonic Corporation Texas Roadhouse, Inc. 24.28 20.05 29.37 41.78 24.57 86.00 44.14 30.54 25.66 46.02 35.37 26.76 40.19 16.80 22.00 12.81 6.5% 4.1% 4.7% 5.8% 6.2% 5.0% 5.9% 3.1% 4.3% 7.2% 3.6% 5.1% 4.9% 8.7% 11.4% 5.7% 308 0.92 Doc. May May Doc. Doc. Doc. Doc. Doc. Doc. 0.00 1.10 11.20 12.53 829 1.87 0.00 1.25 9.7% 16.3% 10.5% 11.6% 938 1.24 0.00 11.41 1.10 1.45 0.00 11.17 0.57 987 619 1.82 0.00 14.68 2.93 1.05 NA 1.01 0.00 13.7% 15.6% 24.9% 12.5% 272 693 597 Aug. 0.88 0.00 4.66 4.30 0.90 0.90 Dec. 0.44 0.00 Current Assets Current Liabilities Total Debt Shr. Equity Debt! Interest T. Capital Capital Coverage Turnover Return On Capital Equity California Pizza Kitchen 38 $ 66 $ 0 $ 208 0.0% NMF 2.7 10.1% 10.1%