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2 Toolkit Objectives  Define economic feasibility  Classify costs and benefits into various categories, including tangible or intangible, direct or indirect, fixed or variable, and developmental or operational  Understand chargeback methods and how they are used

3 Toolkit Objectives  Use payback analysis to calculate the length of time that it takes for a project to pay for itself  Use return on investment analysis to measure a project’s profitability  Use present value analysis to determine the value of a future project measured in current dollars

4 Introduction  You need to know how to calculate costs and benefits when you conduct preliminary investigations, evaluate IT projects, and make recommendations to management  Financial analysis tools are important throughout the systems development life cycle

5 Describing Costs and Benefits  You must review a project’s costs and benefits at the end of each SDLC phase so management can decide whether or not to continue the project  Economic feasibility Economic feasibility  Total cost of ownership (TCO) Total cost of ownership (TCO) Figure TK 3-2 Figure TK 3-3 Figure TK 3-4

6 Describing Costs and Benefits  Cost Classifications – Tangible costs Tangible costs – Intangible costs Intangible costs – Direct costs Direct costs – Indirect costs or overhead expenses Indirect costsoverhead expenses

7 Describing Costs and Benefits  Cost Classifications – Fixed costs Fixed costs – Variable costs Variable costs – Developmental costs Developmental costs – Operational costs Operational costs

8 Describing Costs and Benefits  Managing Information Systems Costs and Changes – Chargeback method Chargeback method 1.No charge methodNo charge method Cost center 2.Fixed charge methodFixed charge method Profit center

9 Describing Costs and Benefits  Managing Information Systems Costs and Changes 3.Variable charge method based on resource usageVariable charge method based on resource usage Resource allocation Connect time Server processing time 4.Variable charge method based on volumeVariable charge method based on volume

10 Describing Costs and Benefits  Benefit Classification – You must classify the benefits that the company expects from a project – Like costs, benefits can be classified as tangible or intangible, fixed or variable, and direct or indirect – Positive benefits Positive benefits – Cost-avoidance benefits Cost-avoidance benefits

11 Cost-Benefit Analysis  Cost-benefit analysis Cost-benefit analysis  Many cost-benefit analysis techniques exist  Three most common methods: payback analysis, return on investment analysis, and present value analysis  The objective is the same: to provide reliable information for making decisions

12 Cost-Benefit Analysis  Payback Analysis Payback Analysis – Payback period Payback period – Carry out the following steps 1.Determine the initial development cost of the system 2.Estimate annual benefits 3.Determine annual operating costs 4.Find the payback period For more information about Payback Analysis, visit scsite.com/sad7e/more, scsite.com/sad7e/more locate Toolkit Part 3 and then the Payback Analysis link.

13 Cost-Benefit Analysis  Payback Analysis – Economically useful life Economically useful life – You calculate the time it takes for the accumulated benefits of an information system to equal the accumulated costs of developing and operating the system Figure TK 3-5 Figure TK 3-6

14 Cost-Benefit Analysis  Payback Analysis – Some managers are critical of it because it places all the emphasis on early costs and benefits and ignores the benefits received after the payback period – Even with its drawbacks, payback analysis is a widely used tool Figure TK 3-7

15 Cost-Benefit Analysis  Using a Spreadsheet to Compute Payback Analysis – First step is to design the worksheet and label the rows and columns – After entering the cost and benefit data for each year, you enter the formulas – You will need a formula to display cumulative totals, year by year Figure TK 3-8 Figure TK 3-9

16 Cost-Benefit Analysis  Return on Investment Analysis Return on Investment Analysis ROI = (total benefits – total costs)/ total costs – Projects must meet or exceed a minimum ROI – You can also use ROI for ranking projects – Measures the overall rate of return for the total period, and annual return rates can vary considerably – Ignores the timing of costs and benefits Figure TK 3-10 For more information about Return on Investment Analysis, visit scsite.com/sad7e/more,scsite.com/sad7e/more locate Toolkit Part 3 and then the Return on Investment Analysis link.

17 Cost-Benefit Analysis  Using a Spreadsheet to Compute ROI – Use cumulative columns but you also will need two overall totals (one for costs and one for benefits) – The last step is to add a formula to calculate the ROI percentage rate – If your data changes, you can modify your worksheet and calculate a new result instantly Figure TK 3-11

18 Cost-Benefit Analysis  Present Value Analysis – Time value of money Time value of money – Present value analysis Present value analysis – Present value Present value – Present value tables Present value tables – Net present value (NPV) Net present value (NPV) Figure TK 3-12 Figure TK 3-13 For more information about Present Value Analysis, visit scsite.com/sad7e/more, scsite.com/sad7e/more locate Toolkit Part 3 and then the Present Value Analysis link.

19 Cost-Benefit Analysis  Present Value Analysis – In theory, any project with a positive NPV is economically feasible – Can also be used to compare and rank projects – Provides solutions to the shortcomings of payback analysis and return on investment analysis Figure TK 3-14 For more information about Time Value, visit scsite.com/sad7e/more, scsite.com/sad7e/more locate Toolkit Part 3 and then the Time Value link.

20 Cost-Benefit Analysis  Using a Spreadsheet to Calculate Present Value – There is one more way to use a worksheet in present value analysis – Most spreadsheet programs include a built-in present value function that calculates present value and other time-adjusted variable factors Figure TK 3-15

21 Toolkit Summary  Must be concerned with economic feasibility throughout the SDLC  Must classify project costs as tangible or intangible, direct or indirect, fixed or variable, and developmental or operational  Every company must decide how to charge or allocate information systems costs and the chargeback method

22 Toolkit Summary  You must also classify system benefits  Present value analysis adjusts the value of future costs and benefits to account for the time value of money  Many companies use present value analysis to evaluate and rank projects

Systems Analysis & Design 7 th Edition End Toolkit 3