Question

Blue Hamster Manufacturing 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, Blue Hamster 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 40% of its pre-tax income or earnings before taxes (EBT) 4. In Year 2, Blue Hamster expects to pay $300,000 and $1,204,875 of preferred and common stock dividends, respectively

Answer 1

• In Year 2, if Blue Hamster has 25,000 Shares of Preferred Stock issued and outstanding, then each preferred Share should expect to receive $12 ($300,000 / 25,000) in annual dividends.

• If Blue Hamster has 200,000 shares of Common Stock issued and outstanding, then the firm’s earnings per share is expected to change from $4.86 ($972,000 / 200,000) in Year 1 to $6.02 ($1,204,875 / 200,000) in Year 2.

• Blue Hamster’s before Interest, Taxes, Depreciation and Amortization (EBITDA) value changed from $5,000,000 in Year 1 to $6,250,000 in Year 2.

• It is hard 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, $888,000 and $1,172,625 respectively. This is because few of the items reported in the Income statement involves payments and receipts of Cash.