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 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, Green Caterpillar expects to pay $100,000 and $1,759,500 of preferred and common stock dividends, respectively.
A. 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.
Green Caterpillar Garden Supplies Inc.
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
B. Given the results of the previous income statement calculations, complete the following statements:
• In Year 2, if Green Caterpillar has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive in annual dividends.
• If Green Caterpillar 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.
• Green Caterpillar’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from in Year 1 to in Year 2.
• It is to say that Green Caterpillar’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.