california pizza kitchen case essay
A bunch of states Pizza Home case article BY Krysta143 Executive Overview California Pizza Kitchen (CPK) was founded in 1985 by simply Larry Flax and Rick Rosenfleld which has a vision of offering clients designer pizzas at reasonable prices. CPKs target audience is geared towards affluent clients making $75, 000 each year, and over the span of 2 decades the business was able to increase from a single location in to 213 places across twenty-eight states and 6 foreign countries. CPK generates revenue from several main options: company restaurants, franchises, and royalties.
CPK stands out from the peers since it offers a compelling menu at affordable prices, does virtually no arketing, and currently creates profits using zero debts. Despite CPKs positive growth projections, the foodstuff industry by the end of 2007 is encountering increased pressure from bigger commodity prices, increasing salary and reduce consumer discretionary income. Over the last 2 years i was able to increase sales simply by 16% while decreasing labor by. 03% in the same period.
Despite our good performance we are currently being pushed by institutional investors to consider additional influence and re-buy outstanding stocks in response to a 10% decline in our stock price. To etermine in the event levering the firm can be beneficial I decided to evaluate some great benefits of leverage getting into different scenario analysis based upon different debt structures 10% 100% leverage. What I seen in my evaluation was that even as leverage the firm there are plenty of benefits we are missing out on such as a larger tax protect, increased ROE and self-disciplined growth impact.
On the gloomy, there is also the chance that we face trouble and it may place a squash on job spending in addition to the most less likely case terrain us in bankruptcy if we are not cautious. It is my personal ecommendation that we should button the organization by 30% of personal debt which should deliver us a tax financial savings to all of us of about $1. thirty-five mm per year and boost each of our ROE to 11. 05%. Case Research California Pizza Kitchen (CPK) is a selfmade style lasagna company located predominantly inside the western location of the United States.
It absolutely was founded in 1985 simply by Larry Flax and Rick Rosenfleld which has a concept aimed at delivering designer pizza in reasonable prices in family friendly environment. This kind of included a modern menu that featured items like, Singapore prawn roll, Shanghai Garlic Noodles, and Poultry Tequila Fettuccine that distinguished it coming from competitors. Their target market was geared towards well-off consumers making at least $75k every year. Its attractive menu and word-of-mouth marketing concept allowed CPK to expand from a single area to 213 locations throughout 28 states and 6 foreign countries.
CPKs key sources of earnings include: company owned restaurants, franchise, and royalties produced from establishing new dispenses. The company as well generates royalties through a license agreement with Kraft Food for the manufacture of frozen pizzas that makes up roughly five per cent of twelve-monthly revenue. Other new sources of revenue range from the new manufacturer extension of ASAP retailers at different airports. This concept has not been completely successful and we plan on divesting the remaining 16 new and taking a $770k write down.
Coming from a marketing perspective, the company spends minimal quantities on advertising compared to sector standards, because CPK relies heavily on word 0T moutn to attract new customers. My spouse and i nls permits us to spend simply around you their overall revenue in advertising. The foodstuff industry was divided into two sections, total service as well as the limited segment. Full support is further more divided into asual dining and fine dining while the limited segment can be subdivided in to fast food and fast casual.
CPK is usually predominantly centered on the limited segment with a sub part in full support. The CAGR for the limited services segment is projected to grow 5. 5%, when CPKs full service is usually projected to grow six. 5%. Going to our 6th. 5% progress rate in 2008, we now have scheduled among 16 18 new retail outlet openings in the coming 12 months. This will need an additional purchase of eighty five million us dollars. A study by the National Association of Restaurants estimates that consumer discretionary spend for ining will increase via 45% to 53% above the next three years.
Even though spending is around the uptick, the industry is experiencing pressure from growing commodity and labor prices with the fresh increases in minimum salary instituted by Bush Operations. Despite the economic pressure, CPK still continues to development under demanding market circumstances. Sales grew by 16% from 2006 to 2006 and royalties increased simply by 36%. Labor as a percentage of sales decreased via 36. 6% to thirty six. 3% in the same period. Even with all of these positive metrics CPKs share price did find a decline within the last month by simply 10% to $22. 0.
The fall in talk about prices was a result of pressure from activist shareholders asking for a buyback of stocks and shares via a reorganization, rearrangement, reshuffling of CPKs capital composition. To respond for this drop in share selling price I have suggested that we explore the possibility of levering up the firm. This could be achieved by issuing debts and repurchasing CPKs shares, however this is a large step to get our business as we have hardly ever used personal debt financing during the past. I decided to analyze the costs and benefits of debts and figure out the value of the firm by analyzing the effect of debts financing (and tax shield) at CPKs WACC.
Recent FCF and Pros and Cons of Debt for CPK Ahead of determining in the event changing the CPK capital structure is appropriate, we initially need to assess the current free cash runs as well as the advantages and disadvantages to accepting debt. During fiscal season 2006, totally free cash flows to the firm totaled 35 dollars. 8 mil (Exhibit 1). Even with the main city required for store openings and increased procedures, the very confident free cash flows shows that CPK should returning income to shareholders. As activist shareholders will want us to button the company and repurchase stocks, we need to be aware of the impact that debt will have on CPK.
The positive impacts of levering CPK with debt happen to be, the tax shield coming from interest paid, and the magnification of ROE. Investors as well view the responsibility that financial debt creates being a benefit. Financial debt is a disciplining force as it would encourage us to consider fewer risks and give attention to generating earnings to meet existing obligations. Another item to consider is definitely the interest rates to get debt. Interest levels are currently low but forecasted to increase, so if we are likely to issue personal debt now is the appropriate time. The primary negative effect of additional influence for CPK is the loss of financial versatility.
If we ssue debt, CPK will create a duty that needs to be fulfilled each year. There could be situations wherever large or perhaps risky assets have to be late or cancelled, because the organization cannot stand up to taking deficits. This would impact the rate when we purchase new retailers and new concepts. New store progress is anticipated to require $85MM in capital and there is the opportunity the extra debt burden sets a press on social media package t 01 Ional Purchase. Based on I-YU6, tnat might De tnree years 0T Tree cash flows. There is not an endless supply of debt, nor does it make sense to over- borrow.
If perhaps CPK borrows to repurchase shares, after that investments must be empered toa rate which is often funded simply by cash flow by operations. Provided the good free cash flows and general steadiness of our organization, this concern should not hold us backside from levering for a reveal repurchase. Before we totally avoided debts financing, and in turn used the proceeds from our 2000 primary public providing (IPO) to pay off all exceptional debt. Since that time we have preserved our funding capacity using a secured $75 million personal credit line with a interest rates of LIBOR interest rate of 5. 6% (plus 0. 80%). Compared to 30- 12 months U. S i9000. Treasuries our company is paying Just 96 bps above primary rate of 5. % (Exhibit 2). Using the scenarios analysis in Exhibit three or more, I reviewed the effects of influence on ROE. Return about equity actions a companies profitability by revealing just how much profit a firm generates with the money shareholders have put in. The basic solution for ROE is: Net income / Aktionär Equity. I found that as I evaluated diverse debt constructions as net income and collateral decrease, ROE always improved.
The main reason that ROE boosts is due to net gain being distributed across less equity within a case with zero power. Our current ROE can be 8. 99% and as you observe from xhibit 3, while the percentage of leverage increases it improves with every scenario of increased debts. By elevating our personal debt structure by 10% time periods, each circumstance will effectively increase the ROE by simply 50bps above the base circumstance with zero debt. The most important benefit of applying additional influence is that even as increase influence it will reduce our EBIT and allow us to shell out less by means of income tax.
Exhibit 3 demonstrates this point. As we move to the best from 20% leverage to 30% power and finally to 40% power each time I actually reduce my taxes paid out to the federal government in larger increments by simply $400k and $1. mm respectively (Exhibit 3). I also required into account the tax deductibility of interest, since it eliminates dual taxation about shareholders. Protecting our cash flow from tax will give shareholders more money to buy additional stocks and options, and will yield higher returns since all of us plan on making use of the additional personal debt to repurchase shares. For example: Spending $22. million obtaining back shares of CPK will take away 1 mil shares from your market, leaving 28. 13 million stocks and shares at $22. 10. This implies CPKs investors with one particular, 000 shares still has $22, 100, as well as the government gets no tax revenue. You cannot find any net change in investor prosperity. Comparing the various scenarios of debt power, we can see that CPKs general valuation continue to be rise right up until we reach 30% personal debt (6. 16% interest rate). When leveraging more than 30% taking on additional debt will be viewed as riskier to our credit card companies and we will be forced to borrow in higher interest levels.
At 35% leverage we assume every additional dollar of financial debt would power us to pay about 9. 5% per year in interest (Exhibit 3). Only at that higher interest rate we run the risk of being unable to invest in all of our positive NPV projects, and can even force ourselves into bankruptcy within an extreme scenario. We have always remained a reliable growth firm and I discover no need to go above the thirty percent threshold and subject ourselves to higher mortgage rates. If I were to go back the past 3 years we have proven that we can increase comp shop sales diligently with zero debt (Exhibit 4).
By taking on 30% wortn 0T aeot we snoul a nave enougn extra casn to Duy DacK enougn snares to Doost ROE and still have money remaining for each of our store development plans next year. I should as well mention that whenever we benchmark yourself compared to different restaurant restaurants, at thirty percent leverage we might be organized like many of our key rivals such as Darden Restaurants, Brinker International and Red Robin the boy wonder (Exhibit 4). In the past we now have outperformed these kinds of 3 competition, but for this to continue it might help to protect our earnings from duty as industry becomes more difficult.
Final Suggestion: As the CFO of California Pizza Kitchen I could say with assurance which the decision to lever the business features less related to appeasing influential shareholders, plus more to do with the tax financial savings and the disciplining effects of dealing with debt. We certainly have already which may the market that business provides a disciplined way of rowth, and I see not any reason that levering in the company wont have this same sobering result when we head to pay in our obligations.
Based on (exhibit 3) My spouse and i am secure with taking on an additional 30% of debt which should deliver us a tax savings to us of approximately $1. 35mm per year and boost our ROE to 11. 05%. We would change and use 100% with the initial proceeds to buy backside shares and re-evaluate how to fund the remaining $85mm in capital we require for the rest of 3 years ago using second financing. If perhaps some of the new shops plans will be riskier opportunities perhaps we scale this kind of back in the close to term to focus on our existing store impact.
By levering up were essentially going to pay less income tax to the government down the road, allowing all of us to defend the profits that we generate in the hard period ahead. Already this year our main business has become challenged by simply higher asset prices, growing minimum wage, higher strength prices, and eroding customer discretionary cash flow, but the long term prospects of your business appear much better. To make sure that we continue to maintain overall flexibility in the interim I will be researching our debt structure on the quarterly basis once we make the decision to button up.
This permits us to regulate he organization and make sure that individuals avoid a predicament where we all cant spend money on positive NPV projects, or perhaps get yourself into a situation where we are at risk of bankruptcy. From a standpoint if you take on personal debt and buying back shares we are able to increase our ROE to be more competitive with other restaurant chains, and mail a positive communication to experts that we have beliefs in our actual business. Whenever we are to act on this idea I believe we must act now, use of low interest rates are not going to last much longer and must secure rates in now before the marketplace deteriorates even more.