Question

The income statement, also known as the profit and loss (P&L) statement, provides a snapshot of the financial performance of a company during a specified period of time. It reports a firm’s gross income, expenses, net income, and the income that is available for distribution to its preferred and common shareholders. The income statement is prepared using the generally accepted accounting principles (GAAP) that match the firm’s revenues and expenses to the period in which they were incurred, not necessarily when cash was received or paid. Investors and analysts use the information given in the income statement and other financial statements and reports to evaluate the company’s financial performance and condition. Consider the following scenario: Cold Goose Metal Works Inc.’s income statement reports data for its first year of operation. The firm’s CEO would like sales to increase by 25% next year.
1. Cold Goose is able to achieve this level of increased sales, but its interest costs increase from 10% to 15% of earnings before interest and taxes (EBIT).
2. The company’s operating costs (excluding depreciation and amortization) remain at 70% of net sales, and its depreciation and amortization expenses remain constant from year to year.
3. The company’s tax rate remains constant at 25% of its pre-tax income or earnings before taxes (EBT).
4. In Year 2, Cold Goose expects to pay $200,000 and $1,922,063 of preferred and common stock dividends, respectively.

Required:
Complete the Year 2 income statement data for Cold Goose.

Income Statement for Year Ending December 31

Year 1 Year 2 (Forecasted)
Net sales $30,000,000
Less: Operating costs, except depreciation and amortization 21,000,000
Less: Depreciation and amortization expenses 1,200,000 1,200,000
Operating income (or EBIT) $7,800,000
Less: Interest expense 780,000
Pre-tax income (or EBT) 7,020,000
Less: Taxes (25%) 1,755,000
Earnings after taxes $5,265,000
Less: Preferred stock dividends 200,000
Earnings available to common shareholders 5,065,000
Less: Common stock dividends 1,579,500
Contribution to retained earnings $3,485,500 $4,284,812

Given the results of the previous income statement calculations, complete the following statements:

a. In Year 2, if Cold Goose has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive (80,60,100,40) in annual dividends.
b. If Cold Goose has 400,000 shares of common stock issued and outstanding, then the firm’s earnings per share (EPS) is expected to change from (17.55,12.66,19.50,13.16) in Year 1 to (25.13,15.52,16.02,21.36) in Year 2.
Cold Goose’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from 13,065,5000,900,000.00,955,000,28,8000 in Year 1 to 32,656,875,39,007,500,11250,000,16,456,875 in Year 2.
c. It is (incorrect or correct) to say that Cold Goose’s net inflows and outflows of cash at the end of Years 1 and 2 are equal to the company’s annual contribution to retained earnings, $3,485,500 and $4,284,812, respectively. This is because (ALL OR ALL BUT ONE) of the items reported in the income statement involve payments and receipts of cash.

Answer 1

Answer:

Cold Goose Metal Works Inc.

a. Preferred Dividend per share = $40 ($200,000/5,000)

b. EPS changed from $12.66 to $15.52

c. EBITDA changed from $9,000,000 to $11,250,000

d. It is incorrect to say that Cold Goose’s net inflows and outflows of cash at the end of Years 1 and 2 are equal to the company’s annual contribution to retained earnings, $3,485,500 and $4,284,812, respectively. This is because ALL BUT ONE of the items reported in the income statement involve payments and receipts of cash.

Explanation:

a) Data and Calculations:

Income Statement for Year Ending December 31

                                                                             Year 1   Year 2 (Forecasted)

Net sales                                                        $30,000,000    $37,500,000

Less: Operating costs,

except depreciation and amortization           21,000,000      26,250,000

Less: Depreciation and

amortization expenses                                     1,200,000          1,200,000

Operating income (or EBIT)                            $7,800,000       10,050,000

Less: Interest expense                                         780,000         1,507,500  

Pre-tax income (or EBT)                                    7,020,000         8,542,500

Less: Taxes (25%)                                              1,755,000          2,135,625

Earnings after taxes                                       $5,265,000       $6,406,875

Less: Preferred stock dividends                         200,000            200,000

Earnings available to common shareholders 5,065,000         6,206,875

Less: Common stock dividends                       1,579,500          1,922,063

Contribution to retained earnings                $3,485,500        $4,284,812

Year 2 (Forecasted)

1. Net sales  $37,500,000 ($30,000,000 * 1.25)

2. Interest expense $1,507,500 ($10,050,000 * 15%)

3. Operating cost = $26,250,000 ($37,500,000 * 70%)

4. Income tax expense = $2,135,625 ($8,542,500 * 25%)

Year 1: Earnings per share  $12.66 (5,065,000/400,000)

Year 2: Earnings per share = $15.52 (6,206,875/400,000)