Advanced Financial Analysis

Week #3 Case Study – California Pizza Kitchen

Case Study Questions: 1. Summarize the Modigiani-Miller (1958) capital structure irrelevance propositions and the concept

of debt tax shields.

a. Discuss optimal capital structure as described within Capital Structure Theory: A Current Perspective

b. Summarize the critiques of the Modigiani-Miller capital structure approach as described within Capital Structure Theory: A Current Perspective

  1. Utilizing case data from Figure 9 answer the following questions a. If CPK’s Debt/Total Equity Capital Ratio was 10%;

i. What would be CPK’s Return on Equity? ii. What would be CPK’s WACC?

b. If CPK’s Debt/Total Equity Capital Ratio was 20%; i. What would be CPK’s Return on Equity?

ii. What would be CPK’s WACC? c. If CPK’s Debt/Total Equity Capital Ratio was 30%;

i. What would be CPK’s Return on Equity? ii. What would be CPK’s WACC?

  1. Utilizing case data from Figure 9 answer the following questions a. If CPK’s Debt/Total Equity Capital Ratio was 10%;

iii. What would be CPK’s anticipated share price? b. If CPK’s Debt/Total Equity Capital Ratio was 20%;

iv. What would be CPK’s anticipated share price? c. If CPK’s Debt/Total Equity Capital Ratio was 30%;

v. What would be CPK’s anticipated share price? d. What role does the tax deductibility of interest play in encouraging debt financing at

CPK?

  1. What capital structure policy would you recommend for CPK?

Case Study Assumptions:

  1. This case introduces the Modigiani-Miller capital structure irrelevance propositions and the concept of debt tax shields.
  2. To calculate CPK’s WACC utilize the CAPM model 3. CPK’s Beta can be modeled using the following formula:

a. L = U[1 + (1 − T)D/E]

i. L = CPK’s Beta with leverage

ii. U = CPK’s Beta without leverage iii. T = Corporate Tax Rate iv. D = Market value of Debt v. E] = Market value of Equity

  1. Beta will need to be adjusted to account for the difference between actual and target debt ratio by unlevering beta to determine an unlevered asset beta and levering beta at the target debt rate.

Case Study Analysis Papers grading rubric

Grading Criteria Maximum

Points Summarize the Modigiani-Miller (1958) capital structure theory as described within Capital Structure Theory: A Current Perspective

15

Summarize your interpretation of optimal capital structure as described within Capital Structure Theory: A Current Perspective

15

Summarize the critiques of the Modigiani-Miller capital structure approach as described within Capital Structure Theory: A Current Perspective

10

Discuss Return on Equity for CPK if; Debt/Total Equity Capital Ratio was 10%; Debt/Total Equity Capital Ratio was 20%; and Debt/Total Equity Capital Ratio was 30%.

15

Discuss WACC for CPK if; Debt/Total Equity Capital Ratio was 10%; Debt/Total Equity Capital Ratio was 20%; and Debt/Total Equity Capital Ratio was 30%.

15

Discuss the anticipated share price for CPK if; Debt/Total Equity Capital Ratio was 10%; Debt/Total Equity Capital Ratio was 20%; and Debt/Total Equity Capital Ratio was 30%.

15

Develop and discuss your proposed capital structure for CPK. 10 Proper spelling, punctuation, report components, and APA Formatting 5 Total 100

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