Chartered Financial Analyst Level 2
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23 An analyst gathers the following financial statement data of three companies financials for the most recent fiscal year (amounts are in $ millions):
| Company A | Company B | Company C |
|---|---|---|
| Net income | 550 | 725 |
| Cash flow from operations | 745 | 810 |
| Capital expenditures | 315 | 432 |
| Net borrowing | -100 | -250 |
| Dividends paid | 135 | 40 |
| Stock repurchases | 65 | 70 |
Based on the FCFE coverage ratio, the company with the greatest dividend safety is:
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A
Company A
B
Company B
C
Company C
Explanation:
Explanation
FCFE Coverage Ratio Calculation:
FCFE Coverage Ratio = FCFE / Total Dividends Paid
Where FCFE (Free Cash Flow to Equity) = Cash Flow from Operations - Capital Expenditures + Net Borrowing
Company A:
- FCFE = 745 - 315 + (-100) = 330
- Total Dividends = 135
- FCFE Coverage Ratio = 330 / 135 = 2.44
Company B:
- FCFE = 810 - 432 + (-250) = 128
- Total Dividends = 40
- FCFE Coverage Ratio = 128 / 40 = 3.20
Company C:
- FCFE = 295 - 75 + (-85) = 135
- Total Dividends = 45
- FCFE Coverage Ratio = 135 / 45 = 3.00
Comparison:
- Company A: 2.44
- Company B: 3.20
- Company C: 3.00
Company B has the highest FCFE coverage ratio (3.20), indicating the greatest dividend safety.
A higher FCFE coverage ratio means the company generates more free cash flow relative to its dividend payments, providing greater safety and sustainability of dividends.
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