Question

3. Income statement Aa Aa 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 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, Green Caterpillar expects to pay $200,000 and $1,042,313 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

Answer 1

	Year 1	Year 2
Net sales	25,000,000.00	31,250,000.00
less: operating costs, except depreciation and amortization	18,750,000.00	23,437,500.00
less: depreciation and amortization	1,000,000.00	1,000,000.00
Operating Income (EBIT)	5,250,000.00	6,812,500.00
Less: Interest expense	525,000.00	1,021,875.00
Pre tax Income (EBT)	4,725,000.00	5,790,625.00
less: Tax (40%)	1,890,000.00	2,316,250.00
Earnings after tax	2,835,000.00	3,474,375.00
Less: preferred stock dividends	200,000.00	200,000.00
Earnings available to common shareholders	2,635,000.00	3,274,375.00
Less: common stock dividends	850,500.00	1,042,313.00
Contribution to retained earnings	1,784,500.00	2,232,062.00

In year 2, if Green Caterpillar has 5,000 shares of preferred stock issued and outstanding then each preferred share should expect to receive $40 in annual dividends.

If Green Caterpillar has 400,000 shares of common stock issued and outstanding then the firm’s EPS is expected to change from 2.13 in year 1 to 2.61 in year 2.

Green Caterpillar’s before interest, tax, depreciation and amortization (EBITDA) value changed from 6,250,000 in year 1 to 7,812,500 in year 2.

It is incorrect to say that Green Caterpillar’s net inflows and outflows of cash at the end of years 1 and 2 are equal to retained earnings $1,784,500 and $2,232,062 respectively. This is because all but one of the item reported in the income statement involve payments and receipt of cash.