Question Consider the following scenario: Fuzzy Button Clothing Company’s income

Question

Question 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 70% 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 $1,537,650 of preferred and common stock dividends, respectively. Complete the Year 2 income statement data for Fuzzy Button, then answer the questions that follow. Round each dollar value to the nearest whole dollar. Fuzzy Button Clothing 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 200,000 Earnings available to common shareholders $4,012,000 Less: Common stock dividends 1,263,600 Contribution to retained earnings Given the results of the previous income statement calculations, complete the following statements: • In Year 2, if Fuzzy Button has 5,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive _____ in annual dividends. • If Fuzzy Button 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. • Fuzzy Button’s before interest, taxes, depreciation and amortization (EBITDA) value changed from ____ in Year 1 to _____ in Year 2. • It is ____ 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, $2,748,400 and $3,387,850 , respectively. This is because ______ of the item reported in the income statement involve payments and receipts of cash.

Explanation / Answer

(1) In year 2, preferred dividend per share = $200,000 / 5,000 = $40 per preferred share

(2) EPS = (Net income - Preferred dividend) / Number of common stock

In year 1, EPS = $(4,212,000 - 200,000) / 400,000 = $4,012,000 / 400,000 = $10.03

In year 2,

Sales = $30,000,000 x 1.25 = $37,500,000

Operating cost = Sales x 70% = $37,500,000 x 0.7 = $26,250,000

EBIT = Sales - Operating cost - Depreciation = $(37,500,000 - 26,250,000 - 1,200,000) = $10,050,000

Interest expense = $10,050,000 x 15% = $1,507,500

EBT = EBIT - Interest expense = $(10,050,000 - 1,507,500) = $8,542,500

Earnings after tax (Net income) = EBT x (1 - tax rate) = $8,542,500 x 0.6 = $5,125,500

EPS = $(5,125,500 - 200,000) / 400,000 = $4,925,500 / 400,000 = $12.31

Note: First 2 questions are answered.

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.