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 75% 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 $300,000 and $938,081 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	$15,000,000
Less: Operating costs, except depreciation and amortization	11,250,000
Less: Depreciation and amortization expenses	600,000	600,000
Operating income (or EBIT)	$3,150,000
Less: Interest expense	315,000
Pre-tax income (or EBT)	2,835,000
Less: Taxes (40%)	1,134,000
Earnings after taxes	$1,701,000
Less: Preferred stock dividends	300,000
Earnings available to common shareholders	1,401,000
Less: Common stock dividends	765,450
Contribution to retained earnings	$635,550	$846,544

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

•	In Year 2, if Cold Goose has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive in annual dividends.
•	If Cold Goose has 200,000 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 earnings 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, $635,550 and $846,544, respectively. This is because of the items reported in the income statement involve payments and receipts of cash.

Answer 1

Income Statement of Cold Goose Metal Works
Particulars	Year 1	Year 2
Net sales	$    15,000,000	$18,750,000
Less: Operating Cost	$    11,250,000	$14,062,500
Less: Deprection	$         600,000	$     600,000
Operating Income (EBIT)	$      3,150,000	$ 4,087,500
Less: Interest Exp	$         315,000	$     613,125
EBT	$      2,835,000	$ 3,474,375
Less: Taxes (40%)	$      1,134,000	$ 1,389,750
Earnings after Taxes	$      1,701,000	$ 2,084,625
Less: Preferred Stock dividends	$         300,000	$     300,000
Earnings available to Common shareholders	$      1,401,000	$ 1,784,625
Less: Common stock dividend	$         765,450	$     938,081
Contribution to retained earnings	$         635,550	$     846,544
1) In year 2, if Cold Goose has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive $12 per share as dividend. (300000/25000)
2) If Cold Goose has 200,000 shares of common stock issued and outstanding, then the firm’s earnings per share (EPS) is expected to change from in Year 1 7 per share (1401000/200000) to in Year 2 8.92 per share (1784625/200000)
3) Cold Goose’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from in Year 1 to in Year 2.
Particulars	Year 1	Year 2
Net sales	$    15,000,000	$18,750,000
Less: Operating Cost	$    11,250,000	$14,062,500
Earnings before interest, taxes, depreciation and amortization (EBITDA)	$      3,750,000	$ 4,687,500
4) 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, $635,550 and $846,544, respectively. This is because of the items reported in the income statement involve payments and receipts of cash.- No, Income statement has been made on the Matching & accrual basis principle i.e. the firm’s revenues and expenses to the period in which they were incurred are match and when they are paid or received. There will be changes in other Balancesheet items.