Question

3. Income statement

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 60% of net sales, and its depreciation and amortization expenses remain constant from year to year.
3.	The company’s tax rate remains constant at 40% of its pre-tax income or earnings before taxes (EBT).
4.	In Year 2, Cold Goose expects to pay $100,000 and $1,642,200 of preferred and common stock dividends, respectively.

Complete the Year 2 income statement data for Cold Goose, then answer the questions that follow. Be sure to round each dollar value to the nearest whole dollar.

Cold Goose Metal Works Inc. Income Statement
For Year Ending December 31
	Year 1	Year 2 (Forecasted)
Net sales	$20,000,000
Less: Operating costs, except depreciation and amortization	12,000,000
Less: Depreciation and amortization expenses	800,000
Operating income (or EBIT)	$7,200,000
Less: Interest expense	720,000
Pre-tax income (or EBT)	6,480,000
Less: Taxes (40%)	2,592,000
Earnings after taxes	$3,888,000
Less: Preferred stock dividends	100,000
Earnings available to common shareholders	3,788,000
Less: Common stock dividends	1,360,800
Contribution to retained earnings	$2,427,200

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

•	In Year 2, if Cold Goose has 10,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive   in annual dividends.
•	If Cold Goose has 500,000 shares of common stock issued and outstanding, then the firm’s earnings per share (EPS) is expected to change from   in Year 1 to   in Year 2.
•	Cold Goose’s before interest, taxes, depreciation and amortization (EBITDA) value changed from   in Year 1 to   in Year 2.
•	It is   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. This is because   of the item reported in the income statement involve payments and receipts of cash.

Answer 1

1) Each preferred share should expect to receive $100,000/10,000 = $10 as annual dividend.

2) EPS is expected to change from $3,788,000/500,000 = $7.576 in year 1 to $4,592,000/500,000 = $9.184 in year 2.

3) EBITDA value changed from 7,200,000+800,000 = $8,000,000 in year 1 to 9,200,000+800000 = $10,000,000 in year 2.

4) 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. This is because all of the item reported in the income statement involve payments and receipts of cash.

Please refer below working:

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