Question

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 necessarily when cash is received or paid. Investors and analysts use the information presented in the income statement, and the other financial statements and reports, to evaluate the company’s financial performance and condition. Consider the following scenario: Blue Hamster Manufacturing 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. Blue Hamster 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 70.00% 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, Blue Hamster expects to pay $300,000 and $2,306,475 of preferred and common stock dividends, respectively. Complete the Year 2 income statement data for Blue Hamster, then answer the questions that follow. Round each dollar value to the nearest whole dollar. Blue Hamster Manufacturing Inc. 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 (40%) 2,808,000 Earnings after taxes $4,212,000 Less: Preferred stock dividends 300,000 Earnings available to common shareholders $3,912,000 Less: Common stock dividends 1,895,400 Contribution to retained earnings $1,605,525 $2,519,025 Given the results of the previous income statement calculations, complete the following statements: • In Year 2, if Blue Hamster has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive ....... in annual dividends. • If Blue Hamster 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. • Blue Hamster’s before interest, taxes, depreciation and amortization (EBITDA) value changed from ......... in Year 1 to   in Year 2. • It is   to say that Blue Hamster’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, $1,605,525 and $2,519,025, respectively. This is because   of the items reported in the income statement involve payments and receipts of cash.

Answer 1

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