ince the investment has a positive NPV it is acceptable in financial terms. The danger highlighted by the analysis of recent financial performance is that existing sales may generate a declining contribution towards meeting interest payments in the future. However, sensitivity analysis shows the proposed expansion is robust in terms of sales volume, since a 31% reduction in forecast sales is needed to eliminate the positive NPV. The proposed expansion is therefore acceptable, but the choice of financing is critical. Springbank should be able to meet future interest payments if the cashflow forecasts for the increase in capacity are sound. However, no account has been taken of expected inflation, and both sales prices and costs will be expected to change. There is also an underlying assumption of constant sales volumes, when changing economic circumstances and the actions of competitors make this assumption unlikely to be true. More detailed financial forecasts are needed to give a clearer indication of whether Springbank can meet the additional interest payments arising from the new debentures. There is also a danger that managers may focus more on the short-term need to meet the increased interest payments, or on the longer-term need to replace the machinery and redeem the debentures, rather than on increasing the wealth of shareholders. Financial risk has increased from a balance sheet point of view and this is likely to have a negative effect on how financial markets view the company. The cost of raising additional finance is likely to rise, while the increased financial risk may lead to downward pressure on the company’s share price. The current debentures represent 54% of fixed assets and after the new issue of debentures, this will rise to 73% of fixed assets. The assets available for offering as security against new debt issues will therefore decrease, and continue to decrease as fixed assets depreciate.
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