Finance Lab · Case study
The capacity decision
Demand is reliable and prices are stable. The board can invest in new equipment, repay debt, or hold course and distribute more to shareholders.
Nova ManufacturingAdvanced15 min
The capacity decision
Nova is turning away orders because the plant is running at capacity. Management must decide how to fund additional output.
The situation
Demand is reliable and prices are stable. The board can invest in new equipment, repay debt, or hold course and distribute more to shareholders.
Constraints
- New equipment adds ৳90,000 of annual depreciation.
- Financing must be either cash, debt, or retained earnings.
- The board wants interest coverage to stay above 2.0×.
The numbers
- Capacity utilisation
- 97%
- Order backlog
- 6 weeks of production
- Cash on hand
- ৳1,518,000
- Long-term debt
- ৳2,400,000 at 9.5%
- Interest coverage
- 2.6×
- Adequate, not comfortable
- Cost of new equipment
- ৳2,000,000, 12-year life
Your decision
Which plan should the board approve?
What strong reasoning looks like
- Compare the return on the investment with the cost of capital.
- Check whether coverage stays above the board's floor.
- Weigh the certainty of demand against the fixed cost being added.
- Recognise that retaining cash has an opportunity cost.
Reflect
- How much of the demand would need to hold for the investment to be justified?
- What would change your mind if you were the finance director?