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solution

Consider the following scenario:

Cold Goose Metal Works 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. Cold Goose 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 25% of its pre-tax income or earnings before taxes (EBT).
4.

In Year 2, Cold Goose expects to pay $300,000 and $1,807,313 of preferred and common stock dividends, respectively.

Cold Goose Metal Works Inc.

Income Statement for Year Ending December 31

Year 1 Year 2 (Forecasted)
Net sales $30,000,000
Less: Operating costs, except depreciation and amortization 24,000,000
Less: Depreciation and amortization expenses 1,200,000 1,200,000
Operating income (or EBIT) $4,800,000
Less: Interest expense 480,000
Pre-tax income (or EBT) 4,320,000
Less: Taxes (25%) 1,080,000
Earnings after taxes $3,240,000
Less: Preferred stock dividends 300,000
Earnings available to common shareholders 2,940,000
Less: Common stock dividends 1,458,000
Contribution to retained earnings $1,482,000 $1,908,937

Given the results of the previous income statement calculations, complete the following statements:

• In Year 2, if Cold Goose has 25,000 shares of preferred stock issued and outstanding, then each preferred share should expect to receive in annual dividends.
• If Cold Goose has 200,000 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.
• Cold Goose’s earnings before interest, taxes, depreciation and amortization (EBITDA) value changed from in Year 1 to in Year 2.
• It is to say that Cold Goose’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, $1,482,000 and $1,908,937, respectively. This is because of the items reported in the income statement involve payments and receipts of cash.

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