California Pizza Kitchen has been operating since 1985 predominantly in California. As of June 2007, they had 213 retail locations in the US and abroad. Analysts have put estimates on the potential of 500 full service locations. CPK 's strategy includes the opening of 16 to 18 new locations this year including the closing of one location. In the second quarter of 2007, revenue increased 16% while comparable restaurant sales grew by 5%. Performing comparatively well against its competitors, CPK 's stock has been depressed recently falling to $22.10 in June making their P/E equal to 31.9 time current earnings. In comparison with BJ 's Restaurants with a P/E of 48.9, CPK appears undervalued. CPK 's direct competitor, BJ 's pays no dividend and has a similar beta and therefore it makes for a good comparative company. Despite uncertainty in the industry and general poor performance among competitors, CPK is performing marginally better than the overall industry.
Susan Collyns has several decisions that need to be made. Her two primary issues are how to finance expansion and the firm’s most appropriate capital structure. The focus of this analysis will be on the change in capital structure through the repurchase of shares at today’s market price of $22.10. The effect of the repurchase will be analyzed from an EBIT breakeven, ROE, EPS, Cost of Capital, and stock price perspective. It should be noted that there is an $85 million cost to fund further expansion of their full service restaurants. This is a known expense that will have to be financed by issuing equity or leveraging the company by taking on debt.
How does debt add value to CPK?
By moderately levering up and repurchasing shares, companies can normally increase their EPS because of the interest tax shield. This typically makes the cost of issuing debt cheaper, than that of issuing equity. The interest tax shield will reduce taxable income so that when debt is used to repurchase