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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.

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.

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 65.00% 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, Fuzzy Button expects to pay $100,000 and $1,419,075 of preferred and common stock dividends, respectively.

Explanation / Answer

Answer:

Fuzzy Button Clothing Company Income Statement for Year Ending December 31 Year 1 Year 2 (Forecasted) Net sales $20,000,000 $25,000,000.00 Less: Operating costs, except depreciation and amortization 13,000,000 $16,250,000.00 Less: Depreciation and amortization expenses 800,000 800,000 Operating income (or EBIT) $6,200,000 $7,950,000.00 Less: Interest expense 620,000 $1,192,500.00 Pre-tax income (or EBT) $5,580,000 $6,757,500.00 Less: Taxes (40%) 2,232,000 $2,703,000.00 Earnings after taxes $3,348,000 $4,054,500.00 Less: Preferred stock dividends 100,000 100000 Earnings available to common shareholders $3,248,000 $3,954,500.00 Less: Common stock dividends 1,171,800 1419075 Contribution to retained earnings 2,076,200 2,535,425

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