Fuzzy Button Clothing Company\'s income statement reports data for its first yea

Question

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 $100,000 and $896,963 of preferred and common stock dividends, respectively.

Explanation / Answer

Year1 Year2 A Net Sales $15,000,000 $18,750,000 (1.25*15000000) B=0.7*A Less: Operating cost except depreciation and amortization $10,500,000 $13,125,000 (0.7*18750000) C Less: depreciation and amortization expenses $600,000 $600,000 D=A-B-C Operating income or EBIT $3,900,000 $5,025,000 E=0.7*D Less:interest expenses $390,000 $753,750 (0.15*5025000) F=D-E Pretax income $3,510,000 $4,271,250 G=0.4*F Less:Taxes(40%) $1,404,000 $1,708,500 H=F-G Earnings after taxes $2,106,000 $2,562,750 I Less:preferred stock dividend $100,000 $100,000 J=H-I Earnings available to commonshareholders $2,006,000 $2,462,750 K Less: common stock dividends $737,100 $896,963 $1.47 $1.79 L=J-K Contribution to retained earnings $1,268,900 $1,565,787 In year 2 , if Fuzzy Button has10000 shares of preferred stock,each preferred share is expected to receive (100000/10000)=$10 dividend If Fuzzy Button has500000 shares of common stock,earning per share is expected to change from (737100/500000)=$1.47 to(896963/50000)=$1.79 Fuzzy Button'sEBITDA changed from $10500000in year 1 to $13125000in year 2 Inflows and outflows of cash at the end of year 1 and 2 is equal to annualcontribution to retained earnings.this is because Sales and Operating costs involve payment and receipt of cash

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