SYS364 Feasibility and Cost Analysis

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

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)

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)

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)

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, …

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

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

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

Cost Benefit Analysis  Comparison of anticipated costs of an Information System to the anticipated benefits

Payback Analysis  How long will it take an information system to pay for itself? 1. Determine the initial development cost of the system 2. Estimate annual benefits 3. Determine annual operating costs 4. Find the break even point by comparing total development and operating costs to the cumulative benefits  See Appendix B in text

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

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

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

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

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

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

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

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