Question

Assignment 03 - Financial Statements, Cash Flow, and Taxes 3. Income statement Аа Аа 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 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 40% of its pre-tax income or earnings before taxes (EBT). 4. In Year 2, Fuzzy Button expects to pay $200,000 and $608,175 of preferred and common stock dividends, respectively.

Answer 1

Answer: Fuzzy Button Clothing Company Income Statement for Year Ending December 31 Year 2 Year 1 (Forecasted) Net Sales $ 10,000,000 $ 12,500,000 Less: Operating Costs, Except Depreciation and Amortization $ 6,500,000 $ 8,125,000 Less: Depreciation and Amortization $ 400,000 $ 400,000 Operating Income (or EBIT) $ 3,100,000 $ 3,975,000 Less: Interest Expense $ 310,000 $ 596,250 Pre-Tax Income (or EBT) $ 2,790,000 $ 3,378,750 Less: Taxes (40%) $ 1,116,000 $ 1,351,500 Earnings after Taxes $ 1,674,000 $ 2,027,250 Less: Preferred Stock Dividends 200,000 $ 200,000 Earnings available to Common Shareholders $ 1,474,000 $ 1,827,250 Less: Common Stock Dividends $ 502,200 $ 608,175 Contribution to Retained Earnings $ 971,800 $ 1,219,075 • In Year 2, if Fuzzy Button has 5,000 Shares of Preferred Stock issued and outstanding, then each preferred Share should expect to receive $40 ($200,000 / 5,000) in annual dividends. • If Fuzzy Button has 400,000 shares of Common Stock issued and outstanding, then the firm's earnings per share is expected to change from $3.69 ($1,474,000 / 400,000) in Year 1 to $4.57 ($1,827,250 / 400,000) in Year 2. • Fuzzy Button's before Interest, Taxes, Depreciation and Amortization (EBITDA) value changed from $3,500,000 in Year 1 to $4,375,000 in Year 2. • It is incorrect 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, $971,800 and $1,219,075 respectively. This is because all but one of the items reported in the Income statement involves payments and receipts of Cash.