Case Studies in Finance – Managing for Corporate Value Creation (7th edition); Bruner, Eades & Schill; Case 33, California Pizza Kitchen pp. 449-465.
Assignment Questions: Use the information in Case 33 to answer the following questions:
1. What is the current operating position of California Pizza Kitchen? What decisions does Susan Collyns face? (4 Marks)
2. For each of the scenarios in case Exhibit 9, calculate the return on the book value of capital and the return on the book value of equity. (2 Marks)
3. For each of the scenarios in case Exhibit 9, calculate, using the classical forms of these formulas, the cost of equity capital and the weighted average cost of capital, assuming that the Market Risk Premium is 5%? (4 Marks)
In assessing the effect of leverage on the cost of capital, you may assume that a firm’s CAPM beta can be modeled in the following manner:
βL = βU * [1 + (1 − T)D/E]
βU is the firm’s 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.
4. Based on the analysis in case Exhibit 9, what is the anticipated California Pizza Kitchen share price under each scenario? How many shares will California Pizza Kitchen be likely to repurchase under each scenario? (4 Marks)
5. What role does the tax deductibility of interest play in encouraging debt financing at California Pizza Kitchen? (2 Marks)
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