Harvard UniversityFINANCE 2020 Euro Designs, Inc

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Harvard UniversityFINANCE 2020

Euro Designs, Inc., expects sales during 2013 to rise from the 2012 level of $3.5 million to $3.9 million. Because of a scheduled large loan payment, the interest expense in 2013 is expected to drop to $325,000. The firm plans to increase its cash dividend payments during 2013 to $320,000. The company's year-end 2012 income statement follows.

Euro Designs, Inc. Income Statement for the Year Ended December 31, 2012

Sales revenue $3,500,000

Less: Cost of goods sold 1,925,000

Gross profits $1,575,000

Less: Operating expenses 420,000

Operating profits $1,155,000

Less: Interest expense 400,000

Net profits before taxes  755,000

Less: Taxes (rate = 40%) 302,000

Net profits after taxes  453,000

Less: Cash dividends 250,000

To retained earnings $ 203,000

1. Use the percent-of-sales method to prepare the 2013 pro forma income statement for Euro Designs, Inc.
2. Explain why the statement may underestimate the company's actual 2013 pro forma income.