Question

In: Finance

The income statement, also known as the profit and loss (P&L) statement, provides a snapshot of...

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:

Cute Camel Woodcraft Company’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. Cute Camel 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, Cute Camel expects to pay $100,000 and $2,815,200 of preferred and common stock dividends, respectively.

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

Cute Camel Woodcraft CompanyIncome Statement for Year Ending December 31

Year 1 Year 2 (Forecasted)
Net sales $30,000,000
Less: Operating costs, except depreciation and amortization 18,000,000
Less: Depreciation and amortization expenses 1,200,000 1,200,000
Operating income (or EBIT) $10,800,000
Less: Interest expense 1,080,000
Pre-tax income (or EBT) 9,720,000
Less: Taxes (40%) 3,888,000
Earnings after taxes $5,832,000
Less: Preferred stock dividends 100,000
Earnings available to common shareholders 5,732,000
Less: Common stock dividends 2,332,800
Contribution to retained earnings $3,399,200 $4,122,800

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

In Year 2, if Cute Camel has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive   in annual dividends.
If Cute Camel has 400,000 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.
Cute Camel’s before interest, taxes, depreciation and amortization (EBITDA) value changed from   in Year 1 to   in Year 2.
It is   to say that Cute Camel’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, $3,399,200 and $4,122,800, respectively. This is because   of the items reported in the income statement involve payments and receipts of cash.

Solutions

Expert Solution

The forecasted income statement for year 2 would be based on the data provided by the company
Cute camel woodcraft company
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 $18,000,000 $22,500,000
Less: Depreciation and amortization $1,200,000 $1,200,000
Operating Income (EBIT) $10,800,000 $13,800,000
Less: Interest Expense $1,080,000 $2,070,000
Pre-tax income (or EBT) $9,720,000 $11,730,000
Less: Taxes (40%) $3,888,000 $4,692,000
Earnings after taxes $5,832,000 $7,038,000
Less : Preferred stock dividends $100,000 $100,000
Earnings available to common shareholders $5,732,000 $6,938,000
Less: Common stock dividends $2,332,800 $2,815,200
Contribution to retained earnings $3,399,200 $4,122,800
Calculation of sales
The sales in year 2 is 25% higher than in year 1. Therefore sales in year 2 is $30,000,000*125%
Calculation of operating cost
Operating cost is equal to 60% of sales and so operating costs for year 2 is $37,500,000*60%
Formula to calculate dividend per preference share
Dividend per share = Total dividend to preference shareholders/Number of preference shares outstanding
Calculation of dividend per preference share
Dividend per share = 100,000/5,000
Dividend per share = $20
In Year 2, if Cute Camel has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive $20  in annual dividend
Formula to calculate Earnings per share (EPS)
Earnings per share = Earnings available to common shareholders/Number of common shares outstanding
Calculation of EPS in year 1
EPS = 5,732,000/400,000
EPS = $14.33
Calculation of EPS in year 2
EPS = 6,938,000/400,000
EPS = $17.345
If Cute Camel has 400,000 shares of common stock issued and outstanding, then the firm’s earnings per share (EPS) is expected to change from $14.33 in Year 1 to $17.345 in Year 2
Calculation of EBITDA for year 1
Net Sales $30,000,000
Less : Operating costs except depreciation and amortization $18,000,000
EBITDA $12,000,000
Calculation of EBITDA for year 2
Net Sales $37,500,000
Less : Operating costs except depreciation and amortization $22,500,000
EBITDA $15,000,000
Cute Camel’s before interest, taxes, depreciation and amortization (EBITDA) value changed from $12,000,000  in Year 1 to $15,000,000   in Year 2
It is incorrect to say that Cute Camel’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, $3,399,200 and $4,122,800, respectively. This is because   of the items reported in the income statement involve payments and receipts of cash
The income statement are prepared based on accrual basis of accounting where the revenue and expenses are recognized if they belong to the current year irrespective of whether cash paid or not
Therefore the net income does not represent the cash inflow and outflow, it shows the profit company makes on the income and expenses of the year.
Therefore the contribution to retained earnings also does not represent the cash inflow or outflow at end of year 1 and year 2 as these are profits accumulated in the balance sheet.

Related Solutions

The income statement, also known as the profit and loss (P&L) statement, provides a snapshot of...
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...
The income statement, also known as the profit and loss (P&L) statement, provides a snapshot of...
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...
Income statement The income statement, also known as the profit and loss (P&L) statement, provides a...
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,...
Income statement The income statement, also known as the profit and loss (P&L) statement, provides a...
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,...
3. Income statement The income statement, also known as the profit and loss (P&L) statement, provides...
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...
3. Income statement The income statement, also known as the profit and loss (P&L) statement, provides...
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...
3. Income statement The income statement, also known as the profit and loss (P&L) statement, provides...
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...
3. Income statement The income statement, also known as a profit and loss (P&L) statement, provides...
3. Income statement The income statement, also known as a profit and loss (P&L) statement, provides a snapshot of a company’s financial performance 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 are incurred, not...
3. Income statement The income statement, also known as the profit and loss (P&L) statement, provides...
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...
3. Income statement The income statement, also known as the profit and loss (P&L) statement, provides...
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...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT