The components of Matlock Ltd's capital structure and their related costs are as follows:

\begin{array}{lr}\text { Current liabilities } & \$ 200,000 \\\text { Long-term liabilities } & \$ 800,000^{1} \\\text { Preferred shares } & \$ 250,000^{2} \\\text { Common shares } & \$ 250,000^{3} \\\text { Retained earnings } & \$ 472,500 \\\text { Net income } & \$ 72,500\end{array}

{ }^{1} \$ 64,000

interest paid

2 \$ 12,500

dividends paid

{ }^{3} \$ 2,500

dividends paid Matlock's corporate tax rate was 25%.Matlock has $250,000 on hand in cash and cash equivalents and is trying to decide whether to pay off $250,000 of debt or redeem the preferred shares.
Required:
A) What is Matlock's current return on equity?
B) What would be the effect on net income of retiring the debt? What would be their new return on equity?
C) What would be the effect on net income of redeeming the preferred shares? What would be their new return on equity?
D) Are there any other factors that would influence your decision?
E) Which of the two actions do you recommend to management? Support your answer.

Wu Limited Had $350,000 of Current Assets and $120,000 of Current

Multiple Choice

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