Question

When the DuPont chemical company first attempted to enter the paint business, it was not successful. According to a company report, in one year it "lost nearly \(\$ 500,000\) in actual cash in addition to an expected return on investment of nearly \(\$ 500,000,\) which made a total loss of income to the company of nearly a million." Why did this report include as part of the company's loss the amount it had expected to earn \(-\) but didn't \(-\) on its investment in manufacturing paint?

Short answer

The DuPont company included the expected return on investment as a loss because it represents the opportunity cost \(-\) the income it could have earned on an alternative, potentially successful investment. By counting this alongside the actual cash loss, the company is assessing both the direct financial loss and the loss of potential gain.

Step-by-step solution

Understand Opportunity Cost

Opportunity cost is a key concept in economics and finance, referring to the potential benefits an entity misses out on when choosing one alternative over another. In DuPont's situation, by investing in the paint business, it forwent other potential opportunities which could have generated a return.

Explain the Loss

The 'total loss of income' for DuPont includes both the actual cash loss (direct financial loss from the business) and lost potential gain (the forgone opportunity). The latter, in this scenario, is the expected return on investment DuPont could've earned if they had put their resources in a different, more profitable venture.

Detail the Reasoning

The report includes the expected earnings not earned as a loss because it's an opportunity cost. By choosing to run a business that results in a loss of \$500,000, DuPont missed out on the chance to earn \$500,000, adding up to a total loss of \$1,000,000. Hence, both actual loss and opportunity costs are deemed significant in evaluating the company's financial position.

Key concepts

DuPont in Business Ventures

Founded in 1802, DuPont has a long history of venturing into diverse industries. When they decided to venture into the paint business, it seemed promising. However, their endeavor did not go as planned. They faced the challenge of calculating both their actual monetary loss and the loss of potential earnings. Here, DuPont experienced a classic case of a business venture not meeting its expected outcomes.

• DuPont's direct financial loss from the paint business was substantial at nearly \( \\( 500,000 \).
• Additionally, they expected to earn another \( \\) 500,000 \) as returns from their investment.
• This builds up to a significant total loss of income, almost reaching the \( \$ 1,000,000 \) mark.

This situation is a clear illustration of the challenges and risks companies face when diversifying into new product lines or industries.

The Concept of Investment Loss

Investment loss can occur in various ways, but the primary concern is the negative difference between the amount invested and the returns generated. In DuPont’s paint venture, the investment did not bring the expected financial returns.

• High upfront costs: Starting a new business usually requires substantial initial investments.
• Lack of market reach: If the products don't find their niche or customer base, sales may not cover the costs.
• Unexpected challenges: Legal, operational, or supply chain issues can drive costs up.

These factors contributed to the financial burden that DuPont experienced when entering the paint business.

Understanding Expected Return

Expected return is a critical financial concept. It represents the anticipated benefit from an investment. Companies usually calculate expected returns to evaluate whether an investment aligns with their financial goals.

• Calculated as a forecast of future returns, based on market analysis.
• Essential in decision-making, allowing firms to choose between different investment opportunities.
• A reflection of what a company hoped to gain, despite the inherent uncertainties.

For DuPont, the expected return in their paint venture was estimated to be approximately \( \$ 500,000 \). By failing to achieve this, they counted it as part of their overall loss, alongside their actual incurred expenses.