California Pizza Kitchen (CPK) was founded in 1985 by Larry Flax and Rick Rosenfield with a vision of offering customers designer pizza at reasonable prices. CPK’s target market is geared towards affluent customers making $75,000 annually, and over the span of 2 decades the business was able to grow from a single location into 213 locations across 28 states and 6 foreign countries. CPK generates revenue from 3 main sources: company restaurants, franchises, and royalties. CPK stands out from its peers because it offers a compelling menu at low prices, does virtually no marketing, and currently generates profits using zero debt. Despite CPK’s positive growth projections, the food industry at the end of 2007 is experiencing increased pressure from higher commodity prices, increasing wages and lower consumer discretionary income. Over the last 2 years we were able to grow sales by 16% while decreasing labor by .03% in the same period. Despite our strong performance we are currently being pressured by institutional investors to take on additional leverage and re-buy outstanding shares in response to a 10% decrease in our stock price. To determine if levering the firm would be beneficial I decided to evaluate the benefits of leverage by doing different scenario analysis based on different debt structures 10% - 100% leverage. What I found in my analysis was that as we leverage the firm there are many benefits that we are missing out on such as a larger tax shield, increased ROE and disciplined growth effect. On the negative side; there is also the chance that we run into trouble and it may put a squeeze on project spending and in the most unlikely case land us in bankruptcy if we are not careful. It is my recommendation that we should lever the firm by 30% of debt which should yield us a tax savings to us of roughly $1.35mm per year and boost our ROE to 11.05%. Case Analysis
California Pizza Kitchen (CPK) is a homemade style pizza company located predominantly in the western region of the United States. It was founded in 1985 by Larry Flax and Rick Rosenfield with a concept aimed at delivering designer pizza at reasonable prices in family friendly environment. This included an innovative menu that featured items like; Singapore shrimp roll, Shanghai Garlic Noodles, and Chicken Tequila Fettuccine that distinguished it from competitors. Their target market was geared towards affluent consumers making at least $75k annually. Its attractive menu and word-of-mouth marketing concept enabled CPK to expand from a single location to 213 locations across 28 states and 6 foreign countries. CPK’s main sources of revenue include: company owned restaurants, franchise, and royalties generated from starting up new franchises. The company also generates royalties through a licensing agreement with Kraft Foods for the manufacture of frozen pizzas that accounts for roughly 5% of annual revenue. Other new sources of revenue include the new brand extension of ASAP stores at various airports. This concept has not been entirely successful and we plan on divesting the remaining 16 new and taking a $770k write down. From a marketing perspective; the company spends minimal amounts on advertising compared to industry standards, as CPK relies heavily on word of mouth to attract new customers. This allows us to spend only around 1% of their overall revenue on advertising. The food industry was divided into two sections; full service and the limited segment. Full service is further divided into casual dining and fine dining while the limited segment is subdivided into fast food and fast casual. CPK is predominantly focused on the limited segment with a sub segment in full service. The CAGR for the limited service segment is projected to grow 5.5%, while CPK’s full service is projected to grow 6.5%. To hit our 6.5% growth rate in 2008, we have scheduled between 16 – 18 new store openings in the coming year. This will require...
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