Your supervisor is considering purchasing the bonds and preferred shares of ARC Corp. She furnishes you the following ARC income statement and expresses concern about the coverage of fixed charges.

1. For the income from affiliates, $600 is undistributed.
2. Includes $80 amortization of previously capitalized interest.
3. Includes $400 of interest implicit in operating lease rental payments.
4. These subsidiaries do not have fixed charges.
5. Interest expense includes:
Interest incurred (except items below) . . . $ 880
Amortization of bond discount. . . . . . . . . . 100
Interest portion of capitalized leases. . . . . 340
Interest capitalized . . . . . . . . . . . . . . . . . . (120)
$1,200
6. The following changes occurred in current year balance sheet accounts:
Accounts receivable. . . . . . . . . . . . . . . . . . $(600)
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . 160
Payables and accrued expenses. . . . . . . . . 120
Dividends payable. . . . . . . . . . . . . . . . . . . (80)
Current portion of long-term debt . . . . . . . (100)
7. Tax rate is 40 percent.

Required:
a. Compute the following earnings coverage ratios:
(1) Earnings to fixed charges.
(3) Earnings coverage of preferred dividends.
(2) Cash flow to fixed charges.
b. Analyze and interpret the earnings coverage ratios in(a).

Transcribed Image Text:

ARC CORPORATION Consolidated Income Statement For Year Ended December 31, Year 5 Sales.. Income ofiess than 50%-owned affiliates (note 1). . . . . . Total revenue Cost of goods sold $27,400 800 28,200 (14,000) 14,200 Gross profit Selling and administrative expenses Depreciation (note 2). Rental expenses (note 3) Share of minority interests in consolidated income (note 4) Interest expense (note 5) $3,600 1,200 1,400 600 1,200 (8,000) 6,200 Income taxes Current Deferred Net income $2,000 1,000 (3,000) 3,200 Dividends 400 Preferred stock Common stock 1,000 (,400) 1,800 Increase in retained earnings