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Feasibility and Cost Analysis: Understanding Costs and Benefits

This session covers feasibility and cost analysis tools, understanding different types of costs and benefits, payback analysis, return on investment analysis, present value analysis, and cost & benefit classifications.

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Feasibility and Cost Analysis: Understanding Costs and Benefits

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Presentation Transcript

  1. SYS364 Feasibility and Cost Analysis

  2. Today’s Agenda • Feasibility and Cost Analysis Tools • Understanding Costs and Benefits • Payback Analysis • Return on Investment Analysis • Present Value Analysis

  3. Cost & Benefit classifications • How much is it? How much do we save? • Tangible • Salaries, hardware, software • Real numbers (you can put it on a P.O.) • Intangible • Customer dissatisfaction, lost sales, employee turnover (doom & gloom) • Customer retention, increased sales, goodwill, employee loyalty (zoom, zoom) • Imagined numbers (we’re guessing)

  4. Budgetary costs • Who is paying? • Direct Costs • Specific to a project (it has a budget no.) • project team salaries, new hardware or software, consultant fees • Who do we blame for this? • Indirect Costs • Overhead: heat, light, network admin, user department employee’s time • Everyone gets blamed (allocated costs)

  5. Profit and Loss statement • Fixed costs • Constant – don’t change with usage • Salaries (head count) • Will never go away • Variable costs • Activity based: supplies, communications • Accountants love to spend a dollar saving a dime (get a dozen quotes to find cheaper commodities like paper) or save a dime and avoid the dollar (save bandwidth or paper costs but loose sales)

  6. Systems Development • For Proposals, the costs are: • Developmental Costs • Occur only during development • Start up costs, initial purchases • Year 0 (from start date to live date) • Operational Costs • Occur during use of system • Maintenance • Year 1, 2, 3, …

  7. Managing Information Systems Costs and Charges • Chargeback method of allocating costs • Fixed charge (allocated, indirect cost) • Variable charge based on usage • Connect time, CPU time, people time • Number of transactions, printer activity • Your turn to stick it too accountants

  8. Understanding Costs & Benefits • Costs can be tangible or intangible, fixed or variable, direct or indirect…know who you are talking to and why • Positive Benefits • Increase revenues, improve services • Cost-avoidance Benefits • Handling work with current staff and avoid hiring additional people

  9. Costing Introduction • OK, how much does it cost? • To pay or not to pay, that is not the question. • A project is economically feasible if the future benefits outweigh the up front costs of the new system • Is it worth it? • To invest or not to invest, that is the question. • Analysts analyze a project’s cost and benefits at the end of each SDLC phase

  10. Cost Benefit Analysis • Comparison of anticipated costs of an Information System to the anticipated benefits

  11. Payback Analysis • How long will it take an information system to pay for itself? • Determine the initial development cost of the system • Estimate annual benefits • Determine annual operating costs • Find the break even point by comparing total development and operating costs to the cumulative benefits • See Appendix B in text

  12. Payback Analysis • Difficult to recognize intangible benefits • Cost graph line is U shaped • High initially, drop and remain stable, then increase with age • Benefit line is inverted U shaped • No benefits in Year 0, increase in Years 1+, then drop off as system becomes the status quo, bureaucratic, and a non-competitive advantage

  13. Return on Investment Analysis • A percentage rate that measures profitability by comparing the total net benefits (the return) to the total costs (the investment) of a project • ROI = (benefits – costs) / costs • Generally based on a 3-5 year time period • Many companies insist on a minimum ROI • ROI may be used for ranking value of projects

  14. Problems with ROI • Measures overall rate of return for the whole project – whereas annual rates of return may vary wildly • Overall ROI ignores the timing of costs and benefits, i.e. cash flow • Look at ROI annually

  15. Present Value Analysis • A dollar you have today is worth more than a dollar you might receive in 5 years • Time value of money • The present value of a future dollar is the amount of money that, when invested today at a specified interest rate, grows to exactly one dollar at a certain point in the future. • The interest rate is called the discount rate • The discount rate = rate of safe investment • Companies generally require a rate of return that is higher than the discount rate

  16. PV example • PV = 1 / (1 + I)n Therefore, the present value of $1 one year from now at 8% is: PV = 1 / (1 + .08)1 = $0.926

  17. Net Present Value • Time adjust both costs and benefits • Multiply the cost/benefit by the appropriate factor • Sum the PV of both the costs and benefits • Spreadsheets have PV & NPV formulas

  18. NPV Considerations • Any positive NPV is theoretically economically feasible • Higher risk, higher value expected by management

  19. Tools • Excel • Build a factor model for “What if…” scenarios • no hard coded values buried in formula • Include Intangibles • Use functions for FV, PV, NPV, Interest

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