Question

Analyze why, despite employing various investment appraisal techniques, large investment projects in big corporations may fail to deliver their estimated cash flows. Critically assess how a failed capital project may affect key stakeholders and shareholder value, and also shape the future strategy of investment capital.

(within 2000 words)

Answer 1

• The reason large investment projects in big corporation may fail to deliver the estimated cash flows is not doing enough due diligence on various parameters like revenue and cost estimates.
• The revenue may be less than estimated due to change in market conditions, change in customer preferences or change in macro economic conditions. The competitor may come up with similar products which can reduce the revenue. Failing to incorporate these factors during assessment can lead to less than expected cash flows.
• There may be cost overrun in the project due to increase in prices of certain key inputs. This leads to increase in cost and hence lower cash flows.
• Increase in the taxes at state or federal level on certain products can increase the tax burden which can lower the cash flows.
• Overall failing to anticipate market conditions and macro variables which can adversely impact the estimated cash flows.

• The failed project impacts various stack-holders like employees, shareholders, suppliers and customers.
• In worst case, the failed project can lead to termination of the employees directly associated with the projects.
• The shareholder may not realize the return that they were hoping to get from the project.
• The failed capital project can reduce the overall shareholders wealth.
• In future, the management should proper anticipation and due diligence of market condition and macro variable before starting capital projects.
• They should scenario analysis by identifying the best and the worst case scenarios and see if the project is still viable to undertake based on probability of best and worst scenarios.
• Also stress test should be carried out to see how the cash flow fluctuates and whether it meets investors expectations.
• The management can also do hypothetical scenario analysis like for e.g. if there is global slowdown like 2008 crisis then how the cash flows would occur and if the project is viable.
• Based on all these things, the investment decision should be taken for capital projects.