Question

You are considering purchasing the preferred stock of a firm but are concerned about its capacity to pay the dividend. To help allay that fear, you compute the times-preferred-dividend-earned ratio for the past three years from the following data taken from the firm’s financial statements:

Year		20X1		20X2		20X3
Operating income	$	20,000,000	$	20,000,000	$	16,000,000
Interest		9,100,000		10,700,000		8,100,000
Taxes		4,000,000		5,200,000		5,300,000
Preferred dividends		1,000,000		700,000		500,000
Common dividends		3,300,000		3,300,000		—

Round your answers to two decimal places.

20X1:

20X2:

20X3:

What does your analysis indicate about the firm’s capacity to pay preferred stock dividends?

Times preferred dividend earned has -Select-declinedincreasedItem 4 each year, which indicates the firm's capacity to pay the dividend has -Select-diminishedimprovedItem 5 .

Answer 1

To calculate the ratio of earnings time preference dividend for each year we need to first calculate the Earnings available for preference shareholder.

Calculation of the same is given below in the below table

Year	2001	2002	2003
Operating Income (a)	$ 20,000,000.00	$ 20,000,000.00	$ 16,000,000.00
Interest Cost (b)	$ (9,100,000.00)	$ (10,700,000.00)	$ (8,100,000.00)
Earnings before Taxes(c ) = (a-b)	$ 10,900,000.00	$    9,300,000.00	$   7,900,000.00
Taxes (d)	$ (4,000,000.00)	$   (5,200,000.00)	$ (5,300,000.00)
Earnings after tax available for preference shareholder( e) = (c-d)	$   6,900,000.00	$    4,100,000.00	$   2,600,000.00
Preference Dividends (f)	$   1,000,000.00	$        700,000.00	$      500,000.00
Earnings to Preference Dividends (e/f)	6.90	5.86	5.20

Considering the above table, we may see that the earnings of the company post taxes are in a decling mode.

Also the ratio of earnings to preference dividend is decling from 6.90 times from 2001 to 5.20 times in 2003