A few of you older folks may remember \"The New Coke\". In 1985, Coca-Cola tried

Question

A few of you older folks may remember "The New Coke". In 1985, Coca-Cola tried to introduce this drink as a replacement for its traditional Coke. They poured millions into promoting New Coke, but consumers never became enthusiastic, and after less than a year, the company gave up and abandoned the whole thing, at a huge loss. When companies make investment mistakes, what do you think that the source of the mistake is likely to be? Is it that the company underestimates the costs, or overestimates the benefits, or uses the wrong discount rate, or fails to understand the risk, or what?

Explanation / Answer

the new coke could be considered as new project for the frim whith its own cash flows.

the sucess of the project depends on the cash flows it could generate for the firm, if discounted value of such cash flows is more than the initial investment and over the return required by the capital issuers it is successful otherwise not,

some of the things which can go wrong while projecting such cash flows are.

1)initial set up costs: if the machinery,infrastructure are underestimated , the project might become unviable.

2) operating costs: eg cost of labour,raw materials. theese need to be projected accurately otherwise costs are underestimated.

3)Gross Revenue/Sales: altough a scenarious analysis on the basis of success chances are done but if the sales simply do not match the projections , company will face a loss.

4)Interest and taxes: any adverse movements in these due to regulatory changes or an adverse credit rating can raise costs due to additional taxes or higher rates on debts.

5)Wrong discount rate: it is essentially the cost of capital,if they are not estimated correctly ,the present value will be different from those that were estimated previously.

6)Competition: sometimes competition can come up with products which are better and cheaper which makes our product undesirable.

7)market risks : eg changes in the economy migh affect consumption patterns and can affect success of the product.

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