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.

Answer 1

1.) Failure of a capital project can occur due to various reasons with the primary among them being incorrect estimation of cash inflows and the discounting rate used to estimate the NPV, IRR.

2.) These two are the most critical factors while judging if a capital project must be taken up by the business or not. Also other factors that contribute to failure of investments are overestimation of demand of the good or service, poor estimation of costs and the related benefits , competition and inaccurate judgement of the overall economic conditions in which the project is operating.

3.) Large investment decisions directly are linked to the economic profit and thereby effect the overall shareholder value. When a project fails, the company write's off huge losses and expenditure incurred at one go which will reduce the overall net profit for the business.

4.) This leads to decrease in stock price due to negative perception of the market and thereby erode the market value of the shares. Also the cost of capital of the company will increase due to increased risk which in turn will push the company to make more money out of future investment projects.

5.) The shareholders as well might disapprove of the future investment projects unless the company demonstrates viable cash flows and raising money might be difficult.

6.) As well obtaining debt will not be easy as the financials will now be bleak and those willing to lend will give it at higher interest rates which may not leave much profits for the stockholders.