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Estimate of the price-earnings ratio

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Question 1.

In Exhibit 9 (California Pizza Kitchen Case 32), assume that CPK changes from the Actual figures (based on end of June 2007) to a scenario of 16% Debt/Capital: (a) Obtain the new Book values of Debt and Equity, (b) If it is announced that the new book value of debt issue is going to be used to repurchase stocks, what would be the new price of CPK stock? How many stocks can be repurchased at this new price using the debt issue?

Question 2.

Why does the estimate of the Price/Earnings (PE) ratio increase with more debt usage for the repurchase program? What causes the cost of equity to increase as CPK increases the Debt/Capital? Also, why do you think the WACC decreases as PK increases the Debt/Capital?

Reference no: EM133305591

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