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Answer: Company C
## Explanation To determine dividend cut risk after a 20% earnings decline, we need to calculate the new dividend coverage ratios: **Current Coverage Ratios:** - Company A: 3.13x - Company B: 2.50x - Company C: 1.12x **After 20% Earnings Decline:** - Company A: 3.13 × (1 - 0.20) = 2.50x - Company B: 2.50 × (1 - 0.20) = 2.00x - Company C: 1.12 × (1 - 0.20) = 0.90x **Analysis:** - **Company C** has the highest risk because its coverage ratio drops below 1.0x (0.90x), meaning earnings would be insufficient to cover dividends. - **Company A** and **Company B** would still have coverage ratios above 1.0x after the decline. While debt ratios provide additional context (Company A has the highest debt at 37%), the immediate dividend coverage calculation clearly shows Company C is most at risk. **Correct Answer: C** - Company C's coverage ratio falls below 1.0x after the earnings decline.
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An analyst gathers the following information of three companies in the same industry:
| Company A | Company B | Company C |
|---|---|---|
| Dividend coverage ratio (x): | 3.13 | 2.50 |
| Debt ratio: | 37% | 22% |
If the earnings of all three companies are expected to decline by 20% due to a business downturn, which company has the highest risk of a dividend cut?
A
Company A
B
Company B
C
Company C