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:

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 65% of net sales, and its depreciation and amortization expenses remain constant from year to year.
3.	The company’s tax rate remains constant at 25% of its pre-tax income or earnings before taxes (EBT).
4.	In Year 2, Blue Hamster expects to pay $200,000 and $2,280,656 of preferred and common stock dividends, respectively.

Complete the Year 2 income statement data for Blue Hamster, then answer the questions that follow. Be sure to 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	19,500,000
Less: Depreciation and amortization expenses	1,200,000	1,200,000
Operating income (or EBIT)	$9,300,000
Less: Interest expense	930,000
Pre-tax income (or EBT)	8,370,000
Less: Taxes (25%)	2,092,500
Earnings after taxes	$6,277,500
Less: Preferred stock dividends	200,000
Earnings available to common shareholders	6,077,500
Less: Common stock dividends	1,883,250
Contribution to retained earnings	$4,194,250	$5,121,531

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

•	In Year 2, if Blue Hamster has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive      in annual dividends.
•	If Blue Hamster 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.
•	Blue Hamster’s earnings 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, $4,194,250 and $5,121,531, respectively. This is because      of the items reported in the income statement involve payments and receipts of cash.

Answer 1