When I create new site collection following error occurs "The URL '/sites/xyz' is invalid. It may refer to a nonexistent file or folder, or refer to a valid file or folder that is not in the current Web"
Is "sites" a managed path? If not this will not work. In standard SharePoint "sites" is a managed path, but it might be worth checking so that is still the case.
The following link guides you in the right direction (for 2010): http://technet.microsoft.com/en-us/library/cc288905(v=office.14).aspx
If it is a managed path, please provide details about the type of site/web-template you are using.