Euro Designs, Inc., expects sales during 2016 to rise from the 2015 level of $3.5 million to $3.9 million. Because of a scheduled large loan payment, the interest expense in 2016 is expected to drop to $325,000. The firm plans to increase its cash dividend payments during 2016 to $320,000. The company’s year-end 2015 income statement follows.

a. Use the percent-of-sales method to prepare a 2016 pro forma income statement for Euro Designs, Inc.
b. Explain why the statement may underestimate the company’s actual 2016 pro forma income.

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Euro Designs, Inc., Income Statement for the Year Ended December 31, 2015 Sales revenue Less: Cost of goods sold Gross profits Less: Operating expenses Operating profits Less: Interest expense Net profits before taxes Less: Taxes (rate = 40%) Net profits after taxes Less: Cash dividends To retained earnings $3,500,000 1,925,000 $1,575,000 420,000 $1,155,000 400,000 $ 755,000 302,000 $ 453,000 250,000 $ 203,000