Question

Consider the following scenario:

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 70.00% 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, Cute Camel expects to pay $300,000 and $2,306,475 of preferred and common stock dividends, respectively.

Complete the Year 2 income statement data for Cute Camel, then answer the questions that follow. 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	$30,000,000
Less: Operating costs, except depreciation and amortization	21,000,000
Less: Depreciation and amortization expenses	1,200,000	1,200,000
Operating income (or EBIT)	$7,800,000
Less: Interest expense	780,000
Pre-tax income (or EBT)	$7,020,000
Less: Taxes (40%)	2,808,000
Earnings after taxes	$4,212,000
Less: Preferred stock dividends	300,000
Earnings available to common shareholders	$3,912,000
Less: Common stock dividends	1,895,400
Contribution to retained earnings	$1,605,525	$2,519,025 • In Year 2, if Cute Camel has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive in annual dividends. • If Cute Camel 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. • Cute Camel's 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, $1,605,525 and $2,519,025, respectively. This is because of the items reported in the income statement involve payments and receipts of cash.

Answer 1

Answer (1):

Completed the Year 2 income statement data for Cute Camel is as follows:

Cute Camel Woodcraft Company Income Statement for Years Ending December 31 Year 1 Net sales $30,000,000 Less: Operating costs, except depreciation and amortization 21,000,000 Less: Depreciation and amortization expenses 1.200.000 Operating income (or EBIT) $7,800,000 Less: Interest expense 780,000 Pre-tax income (or EBT) $7,020,000 Less: Taxes (40%) 2,808,0001 Earnings after taxes $4,212,000 Less: Preferred stock dividends 300,000 Earnings available to common shareholders $3,912,000 Less: Common stock dividends 1,895,400 Contribution to retained earnings $1,605,525 Year 2 (Forecasted) $37,500,000) $26,250,000 1,200,000 $10,050,000 1,507,500 $8,542,500 3,417,000 $5,125,500 300,000 $4,825,500 2,306,475 $2,519,025

Above excel with 'show formula' is as follows:

Cute Camel Woodcraft Company Income Statement for Years Ending December 31 Year 1 Year 2 (Forecasted) | 5 Net sales 30000000 =B5+B5*25% 6 Less: Operating costs, except depreciation and amortization 21000000 =C5*70% 7 Less: Depreciation and amortization expenses 1200000 1200000 8 Operating income (or EBIT) 7800000 =C5-C6-C7 9 Less: Interest expense 780000 =C8*15% 10 Pre-tax income (or EBT) 7020000 =C8-C9 11 Less: Taxes (40%) 2808000 EC10*40% 12 Earnings after taxes 4212000 =C10-C11 13 Less: Preferred stock dividends 300000 300000 14 Earnings available to common shareholders 3912000 =C12-C13 15 Less: Common stock dividends 1895400 2306475 16 Contribution to retained earnings 1605525 2519025 17

Answer (2):

(a) In year 2, if Cute Camel has 25,000 shares of preferred stock issued and outstanding , then each preferred share should expect to receive $12 in annual dividends.

(b) If cute Camel has 200,000 shares of common stock issued and oustanding, then the firm's earnings per share (EPS) is expected to change from $9.48 in Year 1 to $11.53 in Year 2.

(c) Cute Camel's before interest, taxes, depreciation and amortization (EBITDA) value changed from $9.00M in Year 1 to $11.25M in Year 2

(d). It is INCORRECT to say that Cute Camel's net inflows and outflows of cash at the end of years 1 & 2 are equal to the company's annual contribution to retained earnings, $1,605,525 and $2,519,025 respectively. This is because ALL BUT ONE of the item reported in the income statement involve payments & receipts of cash

Working:

(a) Annual dividend per preference share = 300000 / 25000 = $12

(b)

EPS year 1 = 1,895,400 / 200000 = $9.48

EPS year 2 = $2,306,475 / 200000 = $11.53

(c)

EBITDA Year 1 = EBIT + Depreciation and amortization = $7,800,000 + 1,200,000 = $9,000,000 = $9.00 million

EBITDA Year 2 = EBIT + Depreciation and amortization = $10,050,000 + 1,200,000 = $11,250,000 = $11.25 million