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:

Fuzzy Button Clothing 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.	Fuzzy Button 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, Fuzzy Button expects to pay $100,000 and $1,459,238 of preferred and common stock dividends, respectively.

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

Fuzzy Button Clothing CompanyIncome Statement for Year Ending December 31
	Year 1	Year 2 (Forecasted)
Net sales	$30,000,000
Less: Operating costs, except depreciation and amortization	22,500,000
Less: Depreciation and amortization expenses	1,200,000	1,200,000
Operating income (or EBIT)	$6,300,000
Less: Interest expense	630,000
Pre-tax income (or EBT)	5,670,000
Less: Taxes (40%)	2,268,000
Earnings after taxes	$3,402,000
Less: Preferred stock dividends	100,000
Earnings available to common shareholders	3,302,000
Less: Common stock dividends	1,190,700
Contribution to retained earnings	$2,111,300	$2,610,012

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

•	In Year 2, if Fuzzy Button has 10,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive   in annual dividends.
•	If Fuzzy Button 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.
•	Fuzzy Button’s before interest, taxes, depreciation and amortization (EBITDA) value changed from   in Year 1 to   in Year 2.
•	It is   to say that Fuzzy Button’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, $2,111,300 and $2,610,012, respectively. This is because   of the items reported in the income statement involve payments and receipts of cash.

Answer 1

Fuzzy Button Clothing CompanyIncome Statement for Year2 Ending December 31

​​​​​​Particulars	Amount(in$)
Net sales	37,500,000
Less- operating cost except dep & amortization	28,125,000
Less- Dep & amortization	1,200,000
EBIT	8,175,000
LESS- interest	1,226,250
Pre tax income	6,948,750
Less- tax@	2,779,500
Earning after tax	4,169,250
Less-Preferred stock dividend	100,000
Earning available to common stock	4,069,250
Less- common stock dividend	1,459,238
Contribution to retained earning	2,610,012

Preferred share should expect to receive: 100,000/10,000 =$10

Eps for year1 :1,190,700/500,000 =$2.38

EPSfor Year2:1,459,238/500,000 =$2.92

Eps change from in year1 toyear2 : eps2 -eps1/eps1

=2.92-2.38/2.38 =22.69%

EBITDA value changed from in year1 to Year2 :

= EBITDA2 -EBITDA1

=(37,500,000 -28,125,000)-( 30,000,000- 22,500,000)

=1,875,000