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:

Green Caterpillar Garden Supplies 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.	Green Caterpillar 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 80% 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, Green Caterpillar expects to pay $300,000 and $602,438 of preferred and common stock dividends, respectively.

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

	Green Caterpillar Garden Supplies Inc.
	Income Statement for Year Ending December 31
	Year 1	Year 2  (Forecasted)
Net sales	$10,000,000
Less: Operating costs, except depreciation and amortization	8,000,000
Less: Depreciation and amortization expenses	400,000	400,000
Operating income (or EBIT)	$1,600,000
Less: Interest expense	160,000
Pre-tax income (or EBT)	1,440,000
Less: Taxes (25%)	360,000
Earnings after taxes	$1,080,000
Less: Preferred stock dividends	300,000
Earnings available to common shareholders	780,000
Less: Common stock dividends	486,000
Contribution to retained earnings	$294,000	$436,312

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

•	In Year 2, if Green Caterpillar has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive      in annual dividends.
•	If Green Caterpillar 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.
•	Green Caterpillar’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from      in Year 1 to      in Year 2.
•	It is      to say that Green Caterpillar’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, $294,000 and $436,312, respectively. This is because      of the items reported in the income statement involve payments and receipts of cash.

Answer 1

	Year 1	Year 2
Net Sales	10,000,000	12,500,000
Less: Operating costs	8,000,000	10,000,000
Depreciation	400,000	400,000
Operating Income	1,600,000	2,100,000
Less: Interest	160,000	315,000
EBT	1,440,000	1,785,000
Less: Taxes	360,000	446,250
EAT	1,080,000	1,338,750
Preferred Dividends	300,000	300,000
Earnings available to common shareholders	780,000	1,038,750
	486,000	602,438
Common Stock Dividends
Contribution to Retained Earnings	294,000	436,312
Receive = 300,000/25000 = $12
EPS in year 1 = 780,000/200,000 = $3.9
Year 2 = $5.19375 i.e. $5.19
EBITDA in year 1 = $2,000,000
Year 2 = $2,500,000
Incorrect
All but one