The four alternatives considered explicitly in the case are

1. Maintain existing financial policy with no debt;

2. Borrow $23 million (10% debt to total book capital);

3. Borrow $45 million (20% debt to total book capital);

4. Borrow $68 million (30% debt to total book capital).

Using the scenarios in case Exhibit 32.9, what role does leverage play in affecting the return on equity (ROE) for CPK? If the EBIT line is multiplied by a factor of 1.5, how will be the effect of leverage on the risk of equity returns different, compared to the base case? If the EBIT line is multiplied by a factor of 0.5, 

how will be the effect of the risk of equity returns different, compared to the base case?

California Pizza Kitchen

Pro Forma Tax Shield Effect of Recapitalization Scenarios

(dollars in thousands, except share data; figures based on end of June 2007)

		Debt/Total Capital
	Actual	10%	20%	30%
Interest rate	6.16%	6.16%	6.16%	6.16%
Tax rate	32.5%	32.5%	32.5%	32.5%
Earnings before income taxes and interest	30,054	30,054	30,054	30,054
Interest expense	0	1,391	2,783	4,174
Earnings before taxes	30,054	28,663	27,271	25,880
Income taxes	9,755	9,303	8,852	8,400
Net income	20,299	19,359	18,419	17,480
Book value:
Debt	0	22,589	45,178	67,766
Equity	225,888	203,299	180,710	158,122
Total capital	225,888	225,888	225,888	225,888
Return on equity