Introduction to California Pizza Kitchen California Pizza Kitchen is known worldwide for its high quality menu and ingredients, with budget friendly prices. They collect their revenues from three different sources.
Sales from company owned restaurants, royalties from franchised restaurants and royalties from a partnership with Kraft to sell CPK branded frozen pizza in grocery stores. CPK has a “dedication to guest satisfaction and menu innovation and sustainable culture of service. ” CPK has the lowest average bill cost of any other casual dining restaurant, of $13. 30 per guest.Their menu has very few hoices, but the choices that are offered are of high quality and nothing less. Their goal is to extend their franchises to Mexico and South Korea in the coming years being as in the last five years they were capable of increasing total businesses up 38% so a small extension would be of no issue for them. In 1997 they also introduced the idea of an ASAP option. The ASAP options offers guests the most popular items on the menu, pre-made and ready to grab and go.
With society becoming more and more fast paced, the ASAP option has been growing steadily.Upcoming decisions for the Chief Financial Officer (CFO) In recent years restaurants in North America have been seeing a large increase in prices of cost of goods sold (COGS), labour and commodities. In 2007 President Bush increased the minimum wage in the United States from $5. 15 to $7.
25 which was a large increase that most companies were not ready for. There was also a large increase in the cost of petroleum gas which as a result had an effect on the entire economy, making people be much more frugal when it come to their disposable income.When surveyed on the increase in gas prices, the majority of people said that ood purchases would have the be the first thing to be cut in their budgets. There has been a 10% decrease in share prices in recent years and with all of these issues to keep in mind, Susan Collyns (CFO) is faced with a few decisions. 1) With 10% decrease in share price is this an ideal time to repurchase shares and potentially leverage the company’s balance sheet? The repurchase of shares would increase borrowing availability on the company’s current line of credit, which would in turn eventually increase their debt.In 2000, CPK used the proceeds from their IPO to pay ff outstanding debt and have since avoided debt financing.
There are a few advantages that Susan must look at before making this decision. By increasing their leverage it will magnify any sort of success that the company sees, however it will also magnify any downfalls. By issuing debt, she will have a less diluted company because there will be less need for as many investors. (Investors which were Just paid 3-for-2 dividends recently, which was quite costly).
She also has to take in consideration that she will be granted a tax shield which is a reduction on income axes that results from taking an allowable deduction from taxable income 2) CPK has seen customer traffic gains, and also revenue gains throughout the last few years while most other casual dining restaurants have seen a decrease in these areas. CPK spends 1% of their annual income on advertising costs. With net income being $21 and 50% ($105 000) on menu development alone.With some of the extra income that they are receiving compared to their competitors they can decide to either increase this advertising amount and potentially find new customers or they can decrease this mount if they feel confident enough with their existing customer loyalty. Competitors likes Chills, Red Lobster and Olive Garden spend upwards of 4-5% on advertising, so Susan Collyns is faced with the decision of either increasing or decreasing their advertising costs depending on how confident they feel with their branding to date.Recommendations 1) CPK has a strong relationship with their shareholders so if they repurchased shares and divided them between a smaller amount of shareholders but issued the same amount of dividends this would increase the relationship between CPK and heir investors, and also refine the shareholders to investors that are dedicated to the company and genuinely care about the outcome of the business, however this would decrease equity and based on research shown in Exhibit 7 we feel as though increasing equity is the best thing for California Pizza Kitchen.Looking at Exhibit 7, Comparative Financial data between Restaurants, Frisch’s Restaurants have a 0. 44 dividends per share while currently California Pizza Kitchen and Chipotle Mexican Grill have 0.
00. Based on this chart there seems to be a correlation between ividends per share and share price, showing that Frisch’s Restaurants have one of the lowest share prices of $30. 54, while Chipotle Mexican Grill has a share price of $86. 00. Although CPK only has a share price of $22. 0 if they follow in the footsteps of Chipotle Mexican Grill by having 0% debt and an equal debt to equity ratio, the more revenue that comes in, the higher their share price will be.
2) Based on the fact that all other competitors spend roughly four times as much on advertising as California Pizza Kitchen, it would be beneficial for them to up their advertising budget. From 2003 to 2006 net income went from $5 602 000 to $21 000 000 and even though cost of labour, and cost of goods sold have increased in that same span of time, the company still has disposable income to take into consideration.Rather than repurchasing shares we feel as though the company could benefit from increasing their sales budget and becoming more on par with some of their competitors as well as increasing their already high traffic levels and brining in even more revenue than they currently are. They pride themselves on their menu innovation and having a unique menu so if they still used 3% of their revenue n advertising, and 50% of that on menu innovation they would have a flawless menu, and higher customer traffic which is an equation for success and increased net income.When debt is added to California’s Pizza Kitchen, it can be seen that although you see a decrease in Net Income, you see a coinciding decrease in weighted average cost of capital (WACC). With the willingness to take on more debt comes the reward of what is known as the Tax Shield. This is easily seen from the calculation of the weighted increased willingness to take on more debt, they are rewarded with a lower Weighted Average Cost of Capital.
By operating at a lower Net Income, you are saving money in income tax paid which creates an increase in cash flows received on the investment and thus increases the value of the firm. Our calculations below support this statement. In order to find our new number of shares outstanding for each level of debt, the dollar amount of debt was taken and divided by the current share price as given in the case ($22. 10), this was equal to the shares removed by supplanting equity with debt. A sample is shown below for the case of 10%: Shares removed= Debt/Share priceThis number was then subtracted from the original number of shares to get the current number of shares of 28,107??73.
To find EPS, our net income was divided by the new number of outstanding shares: Return on equity was calculated by dividing our net income by our current equity: 9. 52% Finally to calculate WACC our DN and our EN ratios were multiplied by our cost of equity and our cost of debt, with our cost of debt being multiplied by 1 minus our tax rate (0. 35) and added together: WACC= Re (EN) + Rd (DAO (1 (0.
9) + (6. 16% (0. 1) (1-0. 35)) = 5. 86%