Question

Cute Camel Woodcraft 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.	Cute Camel 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 60% 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, Cute Camel expects to pay $100,000 and $1,759,500 of preferred and common stock dividends, respectively.

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

	Cute Camel Woodcraft Company
	Income Statement for Year Ending December 31
	Year 1	Year 2  (Forecasted)
Net sales	$15,000,000
Less: Operating costs, except depreciation and amortization	9,000,000
Less: Depreciation and amortization expenses	600,000	600,000
Operating income (or EBIT)	$5,400,000
Less: Interest expense	540,000
Pre-tax income (or EBT)	4,860,000
Less: Taxes (25%)	1,215,000
Earnings after taxes	$3,645,000
Less: Preferred stock dividends	100,000
Earnings available to common shareholders	3,545,000
Less: Common stock dividends	1,458,000
Contribution to retained earnings	$2,087,000	$2,539,250

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

•	In Year 2, if Cute Camel has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive ________ in annual dividends.
•	If Cute Camel 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.
•	Cute Camel’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from ________in Year 1 to _______in Year 2.
•	It is ________ to say that Cute Camel’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, $2,087,000 and $2,539,250, respectively. This is because ___________ of the items reported in the income statement involve payments and receipts of cash.

Answer 1

FIrst, we need to prepare forecasted income statement for Year 2 as:

Cute Camel Woodcraft company

Income statement for the year ending December 31

	Year 1	Year 2  (Forecasted)	Workings for Year 2
Net sales	$15,000,000	18,750,000	15,000,000 * 125%
Less: Operating costs, except depreciation and amortization	9,000,000	11,250,000	18,750,000 * 60%
Less: Depreciation and amortization expenses	600,000	600,000
Operating income (or EBIT)	$5,400,000	6,900,000
Less: Interest expense	540,000	1,035,000	6900,000 * 15%
Pre-tax income (or EBT)	4,860,000	5,865,000
Less: Taxes (25%)	1,215,000	1,466,250	5865,000 * 25%
Earnings after taxes	$3,645,000	4,398,750
Less: Preferred stock dividends	100,000	100,000
Earnings available to common shareholders	3,545,000	4,298,750
Less: Common stock dividends	1,458,000	1,759,500
Contribution to retained earnings	$2,087,000	$2,539,250

Now , coming to requirements of the questions,

1. In Year 2, if Cute Camel has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive 100,000/5000 = $20 per share in annual dividend
2. If Cute Camel has 400,000 shares of common stock issued and outstanding, then the firm’s earnings per share (EPS) is expected to change from 3545,000/400,000 = 8.8625 in Year 1 to 4,298,750/400,000= 10.7468 in Year 2
3. Cute Camel’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from 5400,000 + 600,000 = $6,000,000 in Year 1 to 6900,000 + 600,000 = $7500,000 in Year 2
4. It is correct to say that Cute Camel’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, $2,087,000 and $2,539,250, respectively. This is because reconciliation of the items reported in the income statement involve payments and receipts of cash