rgonzalez

Grommetco produces plastic insulators for the electrical appliance industry. Excerpts from Grommetco’s financial results for 2010 are as follows:

Net Income (earnings)	$10
Free Cash Flow to Equity	$8
Dividends Paid	$1
Stock Repurchases	$3

Which of the following statements is most accurate? Grommetco’s:

A) dividend payout ratio is 0.4.

B) FCFE coverage ratio is 2.0.

C) dividend coverage ratio is 2.5.

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Dividend coverage ratio = Net Income / Dividends = $10 / $1 = 10.
FCFE coverage ratio = FCFE / (dividends + share repurchases) = $8 / ($1 + $3) = 2.0.
Dividend payout ratio = Dividends / Net Income = $1 / $10 = 0.1.

rgonzalez

Dividend safety is most likely evidenced by:

A) Increase in dividend coverage ratio but not by FCFE coverage ratio.

B) Increase in dividend and FCFE coverage ratios

C) Increase in FCFE coverage ratio but not be dividend coverage ratio.

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Both dividend and FCFE coverage ratios are indicators of dividend safety. FCFE coverage is simply more comprehensive measure and takes into account all cash distributed to shareholders

rgonzalez

Which of the following is most likely to be a symptom of a company that is able to sustain its cash dividend?

A) Issuing new debt to fund projects and cover capital expenditures.

B) A high dividend payout ratio compared to the industry average.

C) A low dividend yield compared to the company's historic average.

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High dividend yields compared to the company’s record suggest that investors are expecting dividends to be cut. Net borrowings are not sustainable, and will eventually require a cut in share repurchases and dividends. A higher-than-average dividend payout ratio creates the risk that dividends may be cut if earnings decline