> . Make the entries called for below to identify your organization and the date of this Economic Analysis. For each
The data for these were entered into the two worksheets,
. After you make the entries on this page, do the following: (1) Examine the Alt.Sol.#1 and Al.tSol.#2
worksheets; (2) read the and study the (which describes how the data for entry worksheet example were generated); (3) then enter your data into the Alt.Sol.#1 and example)> )
%
, 36
2 2
1 5.5 0.05 0
5
$0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 te:
05-2010 IT Economics Corporation
. All rights reserved.
Comparison AltSol#1 AltSol#1 1 1 data only in the Step 2 yellow spaces. All other cells are locked. All calculations are automatic.
1 1 1 probability that a $ 0 benefit will be achieved will be automatically calculated at %
of $1000, or .) Enter probabilities by category (savings, productivity improvements, and cost avoidances) and by year. Use an appropriate life cycle period, but not more than 7 years.
0 0 s
5.5 0 0 0 0 0 0 0 168,000 s
0 0 0 0 0 0 0 6,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 10,000 0 0 0 0 0 0 0 1,800 2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4,700 0 0 0 0 0 0 0 0 0 project costs
0 0 0 0 0 0 0 12,300 0 0 0 0 0 0 0 202,800 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,200 0 0 1,200 0 0 2,250 2,350 2,450 2,550 2,650 0 0 1
68,000 136,000 136,000 136,000 0 0 2
0 10,000 20,000 0 0 3
0 0 0 0 0 0 0 0 0 4
0 0 0 0 0 0 0 0 0 85% 85% 85% 85% 0% 0% 90% 90% 90% 90% 0% 0% 133,600 0 0 Current Year 0.05 Constant Dollars Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total 202,800 0 0 0 0 0 0 0 202,800 1,200 0 0 204,000 2,143 2,132 2,116 2,098 2,076 0 0 0 0 0 0 54,400 0 0 -$149,600 $83,429 $110,884 $109,405 $107,815 $102,603 $0 $0 $364,536 No No Paid Back Paid Back Paid Back Paid Back Paid Back Paid Back 0% 0% $364,536 0 1 2 3 4 5 6 7 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 http://www.iteconcorp.com AltSol#2 0.5 1 Copyright © 2005-2010 IT Economics Corporation http://www.iteconcorp.com 1 1 Calendar Year 1 0 0 0 0 0 0 0 0 99,800 5.5 – Hardware purchases 0 0 0 0 0 0 0 0 0 10,000 0 0 0 0 0 0 0 10,000 – Facilities 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 9,000 0 0 0 0 0 0 0 125,300 Cost of Operations From Baseline – Security and privacy 0 0 0 0 0 0 0 0 0 12,000 12,000 12,000 12,000 0 0 12,000 12,000 12,000 12,000 12,000 0 0 Estimated Benefits From Baseline 68,000 102,000 136,000 136,000 136,000 136,000 0 0 714,000 0 5,000 10,000 20,000 30,000 0 0 0 0 0 0 0 0 0 0 0 5,000 20,000 20,000 25,000 25,000 0 0 – Quality improvements 0% 90% 90% 90% 90% 90% 0% 0% 95% 95% 95% 0% 0% 173,150 0 0 Step 3. You need to take no action in this step. It is informational (see note at right). It assumes that the current year is also the base year (the start of the project). The base year is used as the starting year in the conversion to the constant dollars showing in Step 4. The discount rate is used to calculate constant dollars–that is, dollars that reflect the time value of money for the specific organization. Current Year Base Year Discount Rate Note: Normally, you would enter the current year, base year, and discount rate. They are provided here for the sake of simplicity. 10,884 0 0 Estimated Risk-Adjusted Benefits 0 0 8,163 0 0 – Other increases in revenues 0 0 0 0 0 0 0 0 0 0 0 0 0 Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total 0% 0% 287% The numbers in this row are used as exponents in above PV calculations 0 1 2 3 4 5 6 7 increase market share. http://www.iteconcorp.com UseGuide per year. You enter $10,000 for that year in the worksheet.
DataExample : The phases and tasks in this project as well as the costs by phase are as follows:
*
– Software purchases 60 – Hardware purchases 100 – Communications – Travel $300 – Legacy phase out costs – Other project costs $300 Labor Hours – Software purchases 60 – Hardware purchases 80 – Communications $300 40 – Facilities – Legacy phase out costs $6,000 – Other project costs $0 Labor Hours – Software purchases 60 – Hardware purchases 80 – Communications 100 – Facilities 100 – Travel $300 – Other project costs Other costs (Misc.): $0 Labor Hours – Software purchases – Hardware purchases 160 – Communications $600 50 – Facilities 50 – Travel $200 20 – Legacy phase out costs $10,000 – Other project costs $10,000 $1,000 $10,000 $1,200 $202,800 $1,200 $168,000 $202,800 $1,200 $204,000 Comparative Analysis of Alternative Solutions
Proposal Assessment Criteria
Leading organizations establish a set of “IT investment assessment criteria” that encompasses financial The IT investment assessment criteria are higher level requirements that supplement the requirements In Template 6 (risk analysis), you already used a set of risk criteria similar to those used by many Standard Set of Assessment Criteria Having a standard set of high level IT investment criteria for use organization-wide makes the following • All proposed IT investments can be subject to the same established set of decision criteria, • The various components of the organization can know in advance what high-level criteria must • Because all proposals must meet the high-level criteria as well as the solution criteria, more • The organization’s investment review committee can use the same set of criteria to evaluate
Note the fourth point above. One use of the set of high level criteria is to evaluate alternative solutions If a request for proposal has gone out, the proposals received will first be reviewed by the proposal Using Template 8 Template 8 is an example of a scoring matrix that uses research-based high-level criteria “categories” to For example, the category “Strategic Match” is defined as “The degree of match of the proposed Examples of Organizational Goals Maintain a competitive Gain leadership in the Increase market share Create new products Increase number of Generate brand Obtain international
Increase revenues Improve customer service Increase productivity Increase efficiency Reduce cost Be environmentally Many, many other Value and Risk Criteria, Weights, and Rating Range Usually the criteria are divided into Value criteria categories and Risk criteria categories, as is done in There are also “non-financial” values, which cannot be easily quantified in dollars. For example, keeping With this template, the rating range for each criteria category is from 1 to 5, with 1 being the lowest Defining Rating Scores
Organizations determine and document the meaning of each rating for each criteria category. For The rating on a criteria category is multiplied by the weight given to that category to come up with the Criteria Category Proposal Weighted ROI/NPV 8 5 40
The Value criteria category given the most weight in Template 8 is ROI & NPV. All of the other Value The Risk criteria category given the most weight in Template 8 is Organizational Risk. This type of risk is Risk Criteria Used Again As mentioned earlier, this template uses the same Risk Criteria used in Template 6 in an earlier You will also need the results from the Economic Analysis of your two alternatives (Template 7) as inputs Definitions of the Value and Risk Criteria Categories Used in Template 8 How are the Value and Risk criteria categories defined? Here are the definitions of the criteria used in Value Criteria 1. ROI and NPV: The relative financial return on investment (ROI) and the net present value (NPV) 2. Strategic Match: The degree of match of the proposed solution with the strategic goals and 3. Competitive Response: The extent to which this proposed solution is as good or better than 4. Definitional Certainty: The degree to which sufficient reliable data are available to enable an 5. Executive Support: Strength and likelihood of continued executive support (e.g., do some 6. Quality of Worklife: The extent to which it will improve the quality of worklife for employees 7. Enterprise Architecture: The degree to which it supports the enterprise architecture plan
Risk Criteria 1. Organizational Risk: Extent to which the culture and/or policies and practices of the customers). Extent to which employees with the required knowledge and skills may be 2. Infrastructure Risk: The extent to which it may negatively affect the organization’s IT and non-IT 3. Information Security and Privacy: The extent to which it deviates from or negatively effects the 4. Complexity Risk: Degree of complexity of the proposed solution and/or which will be required 5. External Risk: The extent to which external risks pertain to this solution (e.g., risks associated
Benefits of Template 8 Having a single set of high level criteria and weights for evaluating alternative proposed solutions as well • First, it means that the same high-level criteria will be used with all proposals so that proposals • Second, it increases the reliability and validity of the proposal ratings. Executives, proposal • Third, proposal and acquisition teams use these standard high-level criteria to evaluate • Fourth, the executive investment review committee uses the same high-level criteria to evaluate • And fifth, the high-level criteria can be modified as needed to match the changing needs of the
Your Use of Template 8 Use Template 8 and its criteria category definitions to evaluate your alternative solutions in order to • Use the weights provided in the template. • Use a rating range of 1 to 5 in evaluating an alternative relative to a criterion, with 5 being the
Remember, in Template 4, the top priority risks were given low numbers, such as 1 (highest priority) and IT INVESTMENT ASSESSMENT RATING MATRIX
Solution [Delete this note and enter the alternative’s name and brief description]
Solution [Delete this note and enter the alternative’s name and brief description] Value Criteria Criterion Alternative #1 Alternative #1 Scores Alternative #2 Alternative #2 Scores Strategic 4
Competitive 2
Definitional 2 Executive 2 Quality of 1
Enterprise 1 Total Value Score
Risk
Assessment Criterion Scores Risk Infrastructure 4 Information 4 Complexity 3
External Risk 3 Total Based on benefits-costs-risks tradeoffs, the best solution alternative from among those above is: [Enter Name of Best Solution]
Highest Possible Scores. Since the weights for the Value criteria total 20 and 5 is the best rating in each Value criteria category, Similarly, the weights for the Risk criteria add up to 20 and 5 is the worst rating in each Risk criteria Selecting the Best Alternative The selection of the best solution from the two or three (or more) that you assess can involve many After you have made your decision, enter the name of the selected best solution alternative in the space IMPORTANT NOTES: 1. This template should be used with a Microsoft Word (or other word processor) document. It should
not be used in an Excel worksheet because this is not an appropriate medium for transmitting the
2. The template is adjustable. After the template is copied to a Word document, replace the sample
entries in the cells with your own information. You can change the length and width of the template Economic Analysis of Alternative Solutions
Introduction Economic analysis is a management tool that assist in determining, analyzing, and documenting the NPV Versus ROI Comparisons of the ROI and NPV of the competing alternative solutions will identify the alternative that NPV, on the other hand, is a figure that depicts the present value of the projected future stream of Which is better, an ROI of 67% or a NPV of $2 million? With the example given here, there is no Providing Data for the Economic Analysis Generally, when an alternative solution is identified, its benefits, costs, and risks are documented in Risk Data and Risk Adjustments The ROI and NPV generated by the economic analysis need to be “risk-adjusted” to take into account Template 7 takes the form of an economic analysis worksheet that you can download, as provided in the Benefits and Costs Data Benefits Data Template 2 summarized the new capabilities or functionalities that any solution to the problem must Cost Data The Economic Analysis Worksheet also require cost data for the life off the IT system. You will use the Selecting a Common Life Cycle Period The same number of life cycle years should be used for each of your alternative solutions when making The same number of years for the life cycle is used for every alternative solution so they have a common cycle period to use must be done with good judgement because alternatives often have different years For example, if one alternative has a 3-year life cycle with its peak payoff in years 2 and 3, and a second Where does one get the data for years 4 and 5 when one of the alternatives has, say, a 3-year life cycle? The important point is that the comparisons of the alternative solutions need to be made over the same Economic Analysis Workbook You can download the Economic Analysis Workbook (Template 7) from the list of resources. The After you have studied the examples provided on worksheets 2 and 3, you can replace the sample data The cells of the worksheets are “locked” except for those you need to use to enter your data. The locked If no entries are made for a specific year in the worksheet, that year is ignored. The instructions in The Workbook also explains that all costs and benefits are entered in terms of today’s dollars. If an You must also enter the benefits that an alternative solution is expected to generate and the probability As you may recognize, the worksheets use a relatively simple and practical way of adjusting for risk. Downloading the Workbook When you download the Economic Analysis Workbook, take a little time at first to read the instructions NOTE: Each page of the Workbook is designed so that it will print on one Word Document page. Do
2
Comparison
IT ECONOMICS CORPORATION
ECONOMIC ANALYSIS OF PROPOSED ALTERNATIVE SOLUTION PROJECTS
Getting Started:
1
alternative solution, enter its descriptive name, the executive sponsor’s name (which is your name), and
a brief description of the benefits.
2. The chart and tables below are summaries of the results of an Economic Analysis comparing the
two hypothetical proposed
alternative solutions.
Alt.Sol.#1 and Alt.Sol.#2 (see tabs at bottom of screen). When you replace the data in these two worksheets
with your own data, the chart and tables below will show a financial comparison of your two proposed
alternative solutions.
3
UseGuide
DataExample
into the
AltSol#1
Alt.Sol.#2 worksheets. When you complete your work, your instructor may request that you submit this
entire workbook file rather than printouts of your work.
[Printout area starts here for this page.]
ECONOMIC ANALYSIS OF PROPOSED ALTERNATIVE SOLUTION PROJECTS
Name of Organization and Component:
Date of Economic Analysis:
Alternative Sol. 1 Descriptive Name:
Executive Sponsor:
Brief Description of Benefits:
Alternative Sol. 2 Descriptive Name:
AltSol#2
Executive Sponsor:
Brief Description of Benefits:
Financial Comparison of Alternative Solutions (
Constant Dollars
Summary of Comparison Results
Payback
System
Discount
ROI
NPV
in Years
Life (Yrs)
Rate
Alt. Solution #1:
1
7
0
$3
6
4
5
5.5
0.05
Alt. Solution #2:
287%
$523,
50
All costs and benefits are estimated from the baseline. Because of this,
the baseline is represented by zero dollars in the chart. The baseline is
made up of the costs and benefits that exist before the project to implement
the proposed solution begins. If the project will add a net cost in a year, it
appears as a negative (below the baseline) in the chart. If the project will add
a net benefit, it appears as a positive (above the baseline) in the chart. The
tables above and below and the chart to the left show the life cycle results
from the two projects.
Net Financial Gain or Loss by Year in Constant Dollars
CurYr
CurYr+1
CurYr+2
CurYr+3
CurYr+4
CurYr+5
CurYr+6
CurYr+7
AltSol#1
-$149,
60
$83,429
$1
10,884
$109,
40
$107,815
$102,603
$0
AltSol#2
-$78,450
$87,714
$114,964
$131,433
$141,576
$126,265
Baseline
No
All financial comparison data on this page are in “constant dollars,” which means the
dollar figures are adjusted in terms of the value of today’s dollar.
Copyright ©
20
This material is copyrighted and may not be copied or distributed without written permission from IT Economics Corporation. Certain colleges and universities have permission
to use the material in specific courses, which permission may be withdrawn at the discretion of IT Economics Corporation. Students enrolled in such a course may use the material
only in connection with meeting course requirements as specified by the course instructor and may not use or distribute the material for any other purpose.
AltSol#2
Baseline
Alt Sol 2 System Life Calculation
Alternative Solution 1 – Return on Investment and Net Present Value Analyses
0.5
Please click on UseGuide and DataExample tabs (bottom of page) and read both before starting.
The UseGuide provides helpful comments and the DataExample illustrates how the data for this worksheet example were generated.
Note: Enter Project Name and then
Current Dollars
Copyright © 2005-2010 IT Economics Corporation
http://www.iteconcorp.com
Step 1. Enter Project Name:
Alt. Sol. #1 – Hire Contractor to Recommend and Implement an Off-the-Shelf Graphics Toolset
Step 2. In Current Dollars, enter: estimated dollar costs by year from the baseline to (1) conduct the project and (2) conduct operations for the system implemented system or being implemented. Then (3) estimate the dollar benefits by year from the baseline (total cost savings, total dollar value of the productivity improvements, and total cost avoidance savings). Finally, (4) indicate the probability that the projected benefits will be achieved. (An
8
0%
100
80
$800
Calendar Year
Current Dollars
Current Year
Current Year+1
Current Year+2
Current Year+3
Current Year+4
Current Year+5
Current Year+6
Current Year+7
Total
Estimated $
Investment Cost
Conduct Project
– Project Staff (with overhead)
1
68,000
–
Software purchase
6,000
– Hardware purchases
–
Training
10,000
Calculation of Payback Years
–
Communications
1,800
– Facilities
–
Travel
4,700
– Legacy phase out costs
–
Other
12,300
Total project cost
202,800
Cost of Operations From Baseline
– Operations staff (with overhead)
– Maintenance fees and licenses
1,200
1,250
1,300
1,350
1,400
1,450
7,950
– Security and privacy
– Other operations costs
1,000
1,050
1,100
1,150
5,500
Total operations cost
2,250
2,350
2,450
2,550
2,650
13,450
Total Estimated Dollar Cost
204,000
216,250
Estimated Benefits From Baseline
– Productivity Improvements
102,000
136,000
714,000
– Quality improvements
3,500
1
5,000
20,000
68,500
– Other increases in revenues
– Cost avoidances & reductions
Risk (Probability of Achieving):
– Productivity Improvements 80%
85%
– Quality improvements 0%
90%
– Other increases in revenues 0% 0% 0% 0% 0% 0% 0% 0%
– Cost avoidances & reductions 0% 0% 0% 0% 0% 0% 0% 0%
TOTAL RISK-ADJUSTED BENEFITS
54,400
89,850
124,600
129,100
133,600
665,150
Step 3. You need to take no action in this step. It is informational (see note at right). It assumes that the current year is also the base year (the start of the project). The base year is used as the starting year in the conversion to the constant dollars showing in Step 4. The discount rate is used to calculate constant dollars–that is, dollars that reflect the time value of money for the specific organization.
Base Year
Discount Rate
Note: Normally, you would enter the current year, base year, and discount rate. They are provided here for the sake of simplicity.
[Actual Current Year would be entered]
[Actual Base Year would be entered]
Calendar Year
Step 4. Conversion to Constant Dollars. You need take no action in this step. The Constant Dollars and Totals are automatically calculated from the discount rate identified above in Step 3. Each organization has its own discount rate, which a person must use when making constant dollar (present value) calculations. The federal government uses a discount rate established by the Office of Management and Budget.
Estimated Risk-Adjusted Costs
Investment Cost
– Conduct Project
– Conduct Operations
2,143
2,132
2,116
2,098
2,076
11,765
Total Investment Cost
214,565
Estimated Risk-Adjusted Benefits
– Productivity Improvements 54,400
82,571
104,853
99,860
95,104
90,576
527,364
– Quality improvements 0
3,000
8,163
11,662
14,809
14,103
51,737
– Other increases in revenues 0 0 0 0 0 0 0 0 0
– Cost avoidances & reductions 0 0 0 0 0 0 0 0 0
Total Risk Adjusted Benefits
85,571
113,016
111,521
109,913
104,679
579,101
Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total
Net Gain or Loss in Constant Dollars
Payback Period (“No” means not yet paid back)
Paid Back
ROI by Year: (PV Benefits-PV Costs)/PV Costs
-73%
3893%
5202%
5169%
5139%
4942%
1
70%
Net Present Value: PV Total Benefits less PV Total Costs
<--This the value of the investment over its life cycle adjusted for the time value of money.
The numbers in this row are used as exponents in above PV calculations
1Productivity benefits result from either or both (a) reduced labor cost requirements per unit of output (e.g., new technology that requires less people to perform the same
amount of work; (b) cost savings from reduced need for non-labor resources per unit of output (e.g., new technology that reduces non-labor costs).
2Quality improvements may reduce costs and can increase sales; they usually mean fewer returns from customers, fewer repair costs, and less time spent with customers to
solve problems.
3Other increases in revenue can result from an IT-based improvement, such as making it possible, for example, to create new products, improve customer service, and
increase market share.
4Cost avoidance or reduction may be achieved, for example, by implementing a system that prevents losing a competitive edge, prevents loss through security breaches,
improves disaster protection, avoids the need to buy certain hardware and software, or avoids the need to purchase software licenses, among other possibilities.
Caution: Be careful not to double-count any cost or benefit. If the cost or benefit dollars are counted in one row,
they must not be included in any other row in the table.
Note: This is demonstration software. This software and associated documentation are provided “as is” without warranty of any kind. Moreover, IT Economics Corp. does not
make claims regarding the suitability or performance of this software for any specific purpose. The entire risk arising out of the use or performance of this software and
documentation remains with the person or organization that uses them. IT Economics Corporation shall not be liable for any damages whatsover arising out ot the use of
this software. By using this software, you agree to these provisions.
Copyright © 2001 – 2010 by IT Economics Corporation. All rights reserved.
Yr0
Yr1
Yr2
Yr3
Yr4
Yr5
Alt 1
Alt 2
Baseline 0 $0 $0 $0 $0 $0
Alternative Solution 2: Return on Investment and Net Present Value Analyses
Please click on UseGuide and DataExample tabs (bottom of page) and read both before starting. Alt Sol 2 System Life Calculation
The UseGuide provides helpful comments and the DataExample illustrates how the data for the AltSol#1 worksheet example were generated.
Note: Enter Current Dollars data only in the Step 2 yellow spaces. All other cells are locked. All calculations are automatic.
Step 1. Enter Project Name:
Implement a Graphics Mgmt System Hosted by a Software-as-a-Service (SaaS) Provider
Step 2. In Current Dollars, enter: estimated dollar costs by year from the baseline to (1) conduct the project and (2) conduct operations for the system implemented system or being implemented. Then (3) estimate the dollar benefits by year from the baseline (total cost savings, total dollar value of the productivity improvements, and total cost avoidance savings). Finally, (4) indicate the probability that the projected benefits will be achieved. (An 80% probability that a $1000 benefit will be achieved will be automatically calculated at 80% of $1000, or $800.) Enter probabilities by category (savings, productivity improvements, and cost avoidances) and by year. Use an appropriate life cycle period, but not more than 7 years.
Current Dollars Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total 1
Estimated $ Investment Costs
Conduct Project 0
– Project Staff (with overhead)
99,800
– Software purchases 0 0 0 0 0 0 0 0 0
-Training
Calculation of PayBack Years
– Communications 1,800 0 0 0 0 0 0 0 1,800 1
– Travel 4,700 0 0 0 0 0 0 0 4,700
– Legacy phase out costs 0 0 0 0 0 0 0 0 0 – Other project costs
9,000
Total project cost
125,300
– Operations staff (with overhead) 0 0 0 0 0 0 0 0 0 – Maintenance fees and licenses 0 0 0 0 0 0 0 0 0
– Other operations costs 5,000
12,000
65,000
Total operations cost 5,000 12,000 12,000 12,000 12,000 12,000 0 0 65,000
Total Estimated Dollar Cost
130,300
190,300
– Productivity Improvements1
– Quality improvements2
30,000
95,000
– Other increases in revenues3
– Cost avoidances & reductions4
25,000
120,000
Risk (Probablities of Achieving):
– Productivity Improvements 70% 80% 80% 90% 90% 90% 0% 0%
– Other increases in revenues 0% 0% 0% 0% 0% 0% 0% 0% – Cost avoidances & reductions 85% 90%
95%
TOTAL RISK-ADJUSTED BENEFITS
51,850
104,100
136,800
164,150
173,150
803,200
[Actual Current Year would be entered] [Actual Base Year would be entered] 0.05
Calendar Year
Step 4. Conversion to Constant Dollars. You need take no action in this step. The Constant Dollars and Totals are automatically calculated from the discount rate identified above in Step 3. Each organization has its own discount rate, which a person must use when making constant dollar (present value) calculations. The federal government uses a discount rate established by the Office of Management and Budget. Constant Dollars Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total
Estimated Risk-Adjusted Costs
Investment Cost – Conduct Project 125,300 0 0 0 0 0 0 0 125,300
– Conduct Operations 5,000
11,429
10,366
9,872
9,402
56,954
Total Investment Cost 130,300 11,429 10,884 10,366 9,872 9,402 0 0
182,254
– Productivity Improvements
47,600
77,714
98,685
105,734
100,699
95,904
526,335
– Quality improvements 0
4,286
15,549
27,000
21,155
76,153
– Cost avoidances & reductions
4,250
17,143
19,000
20,516
23,750
18,609
103,268
Total Risk Adjusted Benefits 51,850
99,143
125,848
141,799
151,449
135,668
705,756
Net Gain or Loss in Constant Dollars -$78,450 $87,714 $114,964 $131,433 $141,576 $126,265 $0 $0 $523,502
Payback Period (“No” means not yet paid back) No Paid Back Paid Back Paid Back Paid Back Paid Back Paid Back Paid Back Paid Back
ROI by Year: (PV Benefits-PV Costs)/PV Costs
-60%
768%
1056%
1268%
1434%
1343%
Net Present Value: PV Total Benefits less PV Total Costs $523,502 <--This the value of the investment over its life cycle adjusted for the time value of money.
1Productivity benefits result from either or both (a) reduced labor cost requirements per unit of output (e.g., new technology that requires less people to perform the same
amount of work; (b) cost savings from reduced need for non-labor resources per unit of output (e.g., new technology that reduces non-labor costs).
2Quality improvements may reduce costs and can increase sales; they usually mean fewer returns, fewer repair costs, and less time spent with customers to solve problems.
3Other increases in revenue can result from an IT-based improvement making it possible, for example, to create new products, improve customer service, and
4Cost avoidance or reduction may be achieved, for example, by implementing a system that prevents losing a competitive edge, prevents loss through security breaches,
improves disaster protection, avoids the need to buy certain hardware and software, or avoids the need to purchase software licenses, among other possibilities.
Caution: Be careful not to double-count any cost or benefit. If the cost or benefit dollars are counted in one row,
they must not be included in any other row in the table.
Note: This is demonstration software. This software and associated documentation are provided “as is” without warranty of any kind. Moreover, IT Economics Corp. does not
make claims regarding the suitability or performance of this software for any specific purpose. The entire risk arising out of the use or performance of this software and
documentation remains with the person or organization that uses them. IT Economics Corporation shall not be liable for any damages whatsover arising out ot the use of
this software. By using this software, you agree to these provisions.
Copyright © 2001 – 2010 by IT Economics Corporation. All rights reserved.
After reading this page, be sure to see the Data Example on the next Worksheet
PLEASE DO NOT CHANGE SPREADSHEET SETTINGS
There are many tools available to unlock spreadsheets, but there is no need to unlock the spreadsheet to use it. Those who unlocked the spreadsheet in the past usually did so to change it in some way, which invalidates the spreadsheet results. In college courses, a modified spreadsheet is not acceptable to the instructor and the student will be required to resubmit his or her work using the template spreadsheet in its original form.
SAMPLE ENTRIES IN THE TWO WORKSHEETS
The data now showing in the the AltSol#1 and AltSol#2 worksheets are sample data. The DataExample worksheet (see tab below) shows how the data in the AltSol#1 worksheet were generated. After you have studied the DataExample sheet in relation to the entries in AltSol#1, you should delete the AltSol#1 sheet entries before you begin to enter your own data. A simple way to do this is to type a zero (0) for each entry.
Data Provided For You
The Economic Analysis worksheets are designed to accommodate the types of projects a student is likely to propose in his or her class, while minimizing the burden to the student of using the economic analysis worksheets. The objective is to provide the student with an opportunity to perform an economic analysis on the student’s two best alternative solutions without requiring the student to supply detailed data that might not be readily available. Items of data are provided in the spreadsheet that the student otherwise would have to provide when using an economic analysis tool. They are:
1. A discount rate of 5% is a “provided entry” in the spreadsheet. This rate might be high for government agencies, but it is very low for most commercial organizations. A discount rate is required to compute Net Present Value. Generally speaking, a discount rate takes into account opportunity cost and the cost of capital (e.g., the interest rate that must be paid for the funds). The federal Office of Management and Budget sets the discount rate annually for federal agencies. Commercial firms set their own discount rates. You can obtain more information on these financial terms through Internet searches.
2. The spreadsheet uses the Current Year for both the “Current Year” and the “Base Year.” In other words, this spreadsheet cannot accommodate a project that started before the Current Year.
Entering Benefit and Cost Data
When you enter cost and benefit data for your proposed projects, keep in mind that these need to be “changes from the baseline”– that is, changes from the present levels of benefits and costs.
For example, if the current process generates revenues of $50,000 per year and your proposed project would change the system so it would generate revenues of $60,000 per year, then the benefit in terms of revenue generation is
$10,000
Don’t count a cost or a benefit twice. For example, if the present Cost of Operations is $50,000 per year and the Cost of Operations under your proposed project will be $40,000 per year starting in, say, year 2 of your project, then the entry for Cost of Operations starting in year 2 is -$10,000. Note that this entry is made in the cost section, but it shows a savings. Do not also enter this $10,000 savings in the benefits section starting in year 2.
Never enter a cost or a benefit that you cannot defend or that is not independently verifiable. Since you are estimating a future cost or benefit, you will need to rely on reasonable and acceptable assumptions. Document your key assumptions and verify with stakeholders and others that they are reasonable and that no unstated or unrecognized assumption is being made. (If you are using the worksheets as part of a college course, documenting assumptions is for your own purposes–do not submit documented assumptions to your instructor unless requested.)
Dollar Amounts and Cell Considerations
This is demonstration software so the cells are not as large as they otherwise would be. The size of the cells in the spreadsheet means that using large numbers could cause ##### to appear in a cell because the entered or calculated number is too large for the cell. If you are using the worksheets as part of a college course, this is unlikely to happen with your project, especially if you follow the instructor’s advice to keep the size of your project at a “doable” level. If it does occur with your project, try to modify the amounts entered to reduce their size. For example, you could enter your numbers in thousands, so 20,000 would be entered as 20. In using the results of the worksheet calculations, simply multiply the results by 1000.
One Last Point
This is a reduced-size, customized version of a more complex spreadsheet. In accomplishing the reduction, we don’t think we introduced any errors. However, if you do find an error, please let us know and we will correct it as soon as possible. Best of luck with your economic analyses of projects.
Copyright © 2010 by IT Economics Corporation. All rights reserved.
HOW DATA WERE GENERATED TO COMPLETE THE ALT.SOL. #1 WORKSHEET
Note: Students usually do not need to prepare and submit this type of breakdown of cost information. Rather,
they are usually asked to prepare and submit a work breakdown structure, which shows costs by project phase.
Determining
Project Costs
A work breakdown structure and identification of benefits and costs are necessary to obtain data for the Worksheet.
The information below comes from a work breakdown structure and related cost-benefit analyses.
Project Title: Alt.Sol. #1 -Hire contractor to recommend and implement an off-the-shelf graphics toolset.
Length of Project: The project will be completed in six months and become operational within the Current Year.
Phases and Tasks
Note: These are only contractor hours, costs, and fees, which are paid for by the buyer. Although buyer staff are
members of the integrated project team (IPT), their hours and costs are not shown here. They are covered in a
different budget. Labor hour costs include the related overhead costs.
Phases and Tasks
Details of Non-Labor Costs By Phase
Phase 1
Confirm Requirements (2 weeks)
Labor Hours
Task 1
Orient IPT members and users
Task 2
Confirm Tool Requirements
$300
– Facilities
Labor cost @ ave. $150 per hour:
$24,000
$200
Communications & Travel
$500
Other project costs (Misc.)
Phase Cost:
$24,800
Phase 2
Select Graphics Tool (2 Weeks)
$6,000
Task 3
Conduct market research
Task 4
Evaluate Tools
Task 5
Make site visits
– Travel
$4,000
Labor cost @ ave. $150 per hour:
$27,000
Est. cost of 3 graphics softw sys:
Communications & Travel
$4,300
Other costs (Misc.):
Phase cost:
$37,300
Phase 3
Customize Tool (4 weeks)
Task 6
Design integration programs
Task 7
Design mgmt and user reports
$600
Task 8
Program integration software
Task 9
Program mgmt and user reports
– Legacy phase out costs
Labor cost @ ave. $150 per hour:
$51,000
Communications & Travel
$900
Phase cost:
$51,900
Phase 4
Implement and Transition (8 Wks)
Task 10
Implement systems
160
Task 11
Conduct system tests
Task 12
Plan training program
Task 13
Assist in training program
Task 14
Complete transition
– Vendor custom training program
Labor cost @ ave. $150 per hour:
$66,000
$1,000
Communications & Travel $800
–
Incentive bonus
$11,000
Vendor Training
Other costs (Misc):
Incentive bonus $11,000
Phase cost:
$88,800
Total Cost of Phases:
$202,800
Project Cost Summary:
Current Year Post Project
Labor hours (Project Staff):
$168,000
– License & Maintenance Fee
$1,200
Contract training
(@ 20% of software price)
Communications & Travel
$6,500
Subsequent Years:
Software purchase $6,000
Other project costs (except incentive bonus):
$1,300
Incentive bonus $11,000
Other costs not included above:
Total Expected Current Year Project Cost
Penalty if poor performance
$5,000
Other Costs
License and Maintenance fees to vendor
TOTAL CURRENT YEAR COST:
$204,000
Worksheet AltSol#1 Cost Entries
Entries in the Conduct Project section of the Worksheet
Project staff
Software purchase $6,000
Communications
$1,800
Travel
$4,700
Training $10,000
Other
$12,300
(Excludes CY Lic. & Maint. Fees)
Subtotal:
Entry in the Cost of Operations from Baseline Section
License&Maint. fees
Subtotal: $1,200
TOTAL:
(Note: Benefit entries are explained in below section titled Comments on Worksheet Entries)
Comments on Worksheet Cost Entries:
General Comments
Costs incurred before a project starts are usually budgeted separately and not included in the project costs.
Project costs usually begin when the project starts and end when project ends and the implemented system becomes operational.
License and maintenance fees for vendors may begin during the project’s Current Year and will continue into future years.
The benefits sometimes start during the project, though full benefits usually are not obtainable until after the end of the project.
Project Costs
The Phases and Task columns above show project labor costs and summary costs by phase. Details of the project’s non-labor
costs are shown in the Details of Non-Labor Costs columns above. Most of the costs are under the “Conduct Project” heading (see
worksheet Alt.Sol.#1). The largest single cost is for Project Staff (with overhead). This is followed by Incentive bonus, Training costs,
Software purchase cost, Communications costs, Travel costs, and Other project costs. The “Other project costs” include the Current
Year’s license and maintenance fees, which will be an annual cost after the project ends.
The next group of costs is Cost of Operations from the Baseline. The only entries here are for “Maintenance fee and licenses” and
“Other operations” costs. The “Maintence fees and licenses” are new costs that are not replacing current costs. The “Other operations
costs” are costs that exceed the current operations costs.
Determining Project Benefits
The worksheet provides for four categories of expected benefits, each of which is given a separate row in the worksheet. The economic value of
each benefit is estimated by year and then entered into the worksheet. The major benefit is a projected increase in the productivity of providing
graphics support for proposal preparation. It now costs $6,000 per month to produce graphics for 10 proposals. The new system will
enable 15 or more proposals per month to be supported for the same cost. This increase in graphics-support productivity is equal to $3,000 per
month or $36,000 annually. However, while increasing the productivity of graphics support is important, the principal reason for this IT investment
is to make it possible to increase revenues by generating more high-quality proposals.
Assuming the same hit rate for proposals, the new capability is expected to generate an additional $5 million per year in revenues. Although
many factors contribute to preparing winning proposals and getting the business, it is agreed among the departments that a part of this gain
needs to be attributed to the new graphics support capability. In discussions with the various departments, it is agreed that the enhanced
graphics support will account for about 2% of the gain in expected new revenues, or about $50,000 per year. Adding the $36,000 annual
productivity improvement to the $100,000 in increased revenues is an annual benefit of $136,000 when the system is fully operational. However,
during the “Current Year,” the total will be less because the new system will be operational only a small part of the year. The planners
agree to enter expected “Productivity Improvements” of $68,000 for the Current Year, rising to $136,000 by Current Year+2.
Another expected benefit is an improvement in the quality of the proposals, including fewer errors, less time and resources required for error
correction, better organization of the proposal, and a better physical appearance. This is expected to contribute to winning proposals. The
departments agree that, if the expected revenues materialize, the quality of the proposals due to the enhanced graphics capability will be a
contributing factor. The departments decide that between 2/10ths and 4/10ths of 1% of the increased revenues should be attributed to the
increased quality provided by the graphics support system. This is a benefit of about $10,000 to $20,000 per year. A conservative approach is
taken and only $3,500 is entered for the first year of operation, rising to $20,000 in the fourth year.
Avoiding Double-Counting Benefits
There is frequently the question of how much should an IT improvement claim for an improvement that is expected to increase revenue. In this
case, the increased revenue would be an expected $5 million or more per year. It is tempting for IT project sponsors to claim a good part of
these benefits for their proposed project.They must be very careful in claiming such benefits. In this case, the graphics system is only one of
many enablers of these benefits. The graphic systems will not be responsible for winning the proposals. This means that the sponsor must
negotiate with the line-of-business managers to determine the amount of these benefits that can be claimed by the graphics support project in
its economic analysis and other documents. The sponsor often needs to accept less than he or she believes is fair. Doing so will not put the
proposed investment in jeopardy because the project is an enabler of much larger benefits so it will be supported by other stakeholders.
The most prudent approach, of course, is to not claim benefits based on the results of winning proposals, which recognizes that the graphics
support system will have very little control over the success of proposals. However, the graphics support system is an enabler and will make it
possible to support 50% more proposal preparations and its success will be measured in terms of whether or not it accomplishes this support
objective. The likelihood of substantially increasing proposal-generated revenue is the strongest selling point for this proposal. Moreover,
this proposal directly supports a high priority corporate objective. Therefore, crediting the IT graphics support system with some part of the
increased revenue seems justified, provided it is an amount agreed to by the other departments. What must be avoided is double-counting,
which results when each department claims a percentage of the benefits that add up to more than 100% of the benefits.
Risk Adjustments
Risk is represented in the worksheet as the probability that a stated benefit will be achieved. The probability for achieving the productivity
improvements is judged to be initially 80%, increasing to 85%.as the system matures. For the quality improvements, a relatively high
90% probability is entered. Note that no benefits were claimed for cost savings or cost avoidance.
Management Review and Decision
The economic analyis of Alt.Sol.#1 and Alt.Sol.#2 indicate that Alt.Sol.#2 is the better solution, so it will likely be the one that is recommended
to senior management. The ROI and NPV figures for AltSol#2 may not be as attractive as the figures for some other proposals submitted by
others who are competing for the same project funds. However, senior management will give much weight to the fact that Alt.Sol.#2 (which has
the same objective as Alt.Sol.#1) is a strong enabler of a proposal-preparation process that can potentially produce millions of dollars in
additional revenue for a relatively small investment. The linkage to a high priority objective/key performance indicator will carry much weight.
Why No Entries in Certain Rows?
Notice that certain rows have no entries. There are two reasons for this. As mentioned above, two of the four cost rows under Cost of Operations
from the baseline have no entries. This doesn’t mean there will be no “operations staff” cost or “security and privacy” costs. Such costs will
occur but they are expected to be about the same as the current (baseline) costs, so there are no entries for them in the worksheet. The
second reason why a row may have no entries is that the category simply is not applicable. This is why there are no entries for Cost avoidance
in the row under Estimated benefits from the baseline. There are no cost avoidances because they are already presented in another row
of the spreadsheet (e.g., cost avoidance due to increased quality).
IT Acquisition Template 8
value, non-financial value, and risks. They use this set of criteria to evaluate proposed alternative
solutions, before they become proposals, as well as to evaluate fully-developed proposals.
specified to solve the problem. In other words, a proposed solution must not only solve the problem
(that is, meet all the problem solution requirements), but it must do so in a way to satisfy the IT
investment assessment criteria. In this way, the “best solution” is identified—the one that will not only
solve the problem but contribute the most to the organization in doing so. The IT investment
assessment criteria takes the form of a standard set of high level assessment criteria used organization-
wide.
organizations, and you will use those criteria again here along with other criteria in performing a cost-
benefits-risks tradeoff analysis to select the best alternative solution.
possible:
rather than each proposal having individually created criteria
be met in order for their internal proposal to be approved or for a proposal submitted by an
external source to be selected. This helps internal groups as well as external source to prepare
better proposals.
proposals will be received that are responsive to the organization’s priority goals and objectives,
including alignment, timeliness, and benefit-cost-risk standards.
and compare (a) internally-generated alternative solutions to a problem, (b) internal proposals
that compete with other internal proposals, and (c) proposals submitted by external sources.
to a specific performance problem in order to identify the best solution. (This is how you will use
Template 8). In leading organization, the various proposal teams use the high-level criteria to evaluate
their own alternative solutions to identify the best one. They will develop the best solution into a
proposal that will be submitted to an executive investment review committee. The committee receives
proposals from various parts of the organization and uses the same set of high level criteria to evaluate
the competing proposals submitted to them. The committee decides which among those submitted are
best for the organization and should be funded.
selection committee and then the proposal that this committee selects will be sent to the executive
review committee. This proposal will have to compete with all of the other proposals for funding. The
investment review committee, using the established high-level criteria, reviews the various proposals
and decides which should be funded. The established high-level criteria are equally effective evaluating
both internally-prepared proposals and externally prepared proposals. The Clinger-Cohen Act of 1996
requires federal agencies to establish such a set of IT investment criteria for organization-wide use in
evaluating and selecting the IT proposals to fund.
organize a standard set of high level IT investment assessment criteria. The categories and their
definitions are based on research involving successful and unsuccessful IT acquisitions. Although the
criteria categories and their definitions have broad applicability to organizations, the specific criteria
within a category will vary to reflect the needs of the particular organization.
solution with the strategic goals and objectives of the organization.” This definition is applicable to any
organization and its proposals, but organizations have different goals and objectives so the specific
criteria they will include in this category will vary. Here are some examples of goals that illustrate how
diverse the goals can be. An organization is likely to have some of these goals but not all of them.
edge
field
partners
recognition
business
friendly
possibilities
Template 8. The term “value” is used, rather than “benefit,” because value is more encompassing. In
terms of financial value, it is what it is left after the cost is taken into account. For example, if a proposal
will generate $2 million in income and its cost (investment) is $1 million, the financial value of the
proposal is $1 million.
customers happy is an important non-financial value; they may not buy more products or services (i.e.,
increase the ROI), but they are likely to stay as customers, which is a value to the organization.
The template also gives a certain weight to each criteria category. The amount of weight given is
intended to represent the relative importance of that criteria category to the particular organization.
Most organizations give ROI/NPV the highest Value weight, though sometimes (mainly in government
agencies) Strategic Match is given the same or even a higher weight.
score and 5 being the highest score.
example, a “1” rating on ROI/NPV would be for a proposal with a low ROI over the next three years and
a low or modest NPV. A “5” rating on ROI/NPV might be for a proposals with an ROI forecast of 300% or
more and a large NPV. Organizations define, document, and distribute a guide explaining the meaning of
each rating. In this way, a each rating from “1” to “5” (if a 5-point scale is used) has the same meaning
throughout the organization.
proposal’s weighted score for a criteria category. For example, if the category ROI/NPV has a weight of 8
and a proposal receive a “5” rating on ROI/NPV, the 5 rating would be multiplied by the weight of 8, so
the entry in the Weighted Score cell would be 40 (8 x 5 = 40).
Category
Weight
Rating
Score
criteria in the template are non-financial – that is, they are not easily measured in financial terms.
However, they are measurable in non-financial terms. For example, Quality of Worklife can be measured
via a survey of the staff expected to use the proposed system. If they respond that they believe the
proposed system will enrich their jobs, broaden their skills, and increase their pay, the proposal would
be rated high on Quality of Worklife. If the survey shows the opposite results, there would be a low
rating on Quality of Worklife. (A low rating for a category is a sign that the proposal needs to be
improved or rejected.) Of note, a high rating in this category can lead to future increases in ROI/NPV.
the most common cause of project failures. Many criteria are normally included in this category. The
objective is to identify the presence of Organizational Risk in a proposal before it is selected for funding.
Then, depending on the amount and type of risk, either eliminate the proposal or modify it to avoid as
much risk as possible and mitigate the risk that cannot be avoided. The result should be less project
failures.
“screening out” of evaluation of alternative solutions. As a result, you know much about the risk
characteristics of the two solution alternatives you selected. You may wish to refer to your results in
Template 6 as an aid to determining the risk inputs for Template 8. However, you have more
information about your alternatives now, so do not be reluctant to change your risk ratings for Template
8 if you believe you should.
for Template 8.
Template 8.
of this investment compared with competing investments
objectives of the organization.
what competitors are doing.
accurate definition of the problem and/or the future environment in which the proposed
solution must function.
executives oppose this solution).
and others who will staff the activities.
(interoperability, direction of growth, etc.)
organization may present problems. Extent to which there may be insufficient buy-in, support,
or understanding on the part of key stakeholders (e.g., affected managers, employees,
unavailable when needed to support the project and/or the implemented system.
infrastructure (e.g., will it slow down other processes, reduce needed flexibility, place unusual
work demands on some groups?).
established standards and requirements for information security and privacy.
of the implementation project.
with strategic partners or with vendors or with outside overseers or interest groups, negative
impacts on the environment, possible incompatibility with law or regulations).
as proposals from contractors has many advantages for an organization.
can be compared. If separate criteria were used for each proposal, the proposals could not be
compared.
teams, and other stakeholders gain experience and expertise using the high-level criteria.
Executives see the value of the ratings in the results produced (e.g., cost savings, improved
organizational performance, less risk).
alternative proposed solutions in order to select the best candidates to become formal
proposals—they know that proposed solutions that have high ratings on the criteria have the
best likelihood of being funded.
the proposals it receives. In other words, everyone is using the same high-level criteria.
organization. For example, the Value criteria category “Strategic Match” refers to the extent to
which a proposal is aligned with the strategic goals of the organization. If the strategic goals
change, the alignment must be with the new strategic goals, not with the old ones.
determine which one is best and should become the basis of a request for proposal. In evaluating your
alternatives, do the following:
highest rating. Remember that a “5” rating on a Value Criterion is good but a “5” rating on a Risk
Criterion is bad.
2 (second highest priority). In this template, high numbers are used to indicate much value or much risk,
depending on whether value or risk is being evaluated.
Alternative #1
Alternative #2
Assessment
Weight
Ratings
Weighted
Ratings
Weighted
ROI and NPV 8
Match
Response
Certainty
Support
Worklife
Architecture
Weighted
Criteria
Weight
Alternative #1
Ratings
Alternative #1
Weighted
Scores
Alternative #2
Ratings
Alternative #2
Weighted
Organizational
6
Risk
Security
Risk
Weighted
Risk Score
Template 8. IT Investment Assessment Rating Form
the highest weighted Value score for an alternative solution is 100 (an alternative would need to get a
“5” rating in every category).
category. Therefore, the worst weighted Risk score is 100. A 100 score for Value is good, but a 100 score
for Risk is bad. No, you do not subtract the Risk score from the Value score, which would be mixing
apples and oranges. Incidentally, some organization regularly did this before realizing that it is illogical
and resulted in poor selections of proposals.
value-risk tradeoffs. Is it better to have greater value with greater risk or lower value with lower risk? It
depends on the organization, its goals, problems, and other considerations. Organizations in highly
competitive environments are more likely to select an innovative high payoff solution with more risk
than a run-of-the-mill low payoff solution with little risk. Government agencies tend to accept less risk
than commercial organizations. In your case, you need to select the alternative solution that you believe
is on balance the best to solve your problem. –and you should be prepared to defend your choice with
evidence and fact-based assumptions.
provided in the template.
document to others or for printing it for distribution.
and its cells after you copy the template to your document. If you put your cursor on a line in the
template, the line can be moved horizontally or vertically, depending on the line, to best fit your
information. There is no need to color any of the cells in your Word version, though color is used in
the example above.
IT Acquisition Template 7
financial costs and financial benefits of alternatives. The product of the economic analysis of an IT
acquisition alternative solution is a projection of the risk-adjusted financial return on investment (ROI)
and the net present value (NPV) of the investment. The material below discusses the concepts
underlying economic analysis. At the end, it provides a link to an economic analysis worksheet that
applies the concepts and generates risk-adjusted ROI and NPV figures for an IT acquisition alternative or
a proposal.
is most advantageous from a financial standpoint. Both ROI and NPV are used in making the
comparisons because they have different meanings and both provide valuable information for the
decision makers. ROI is a ratio that compares two quantities, such as investing $3 million and receiving
$5 million in return in terms of current dollars over a five-year period. This is an ROI of 67% (i.e., net gain
divided by the cost, or $2 divided by $3, where both the net gain and the cost are in today’s dollars).
benefits and costs. It can determine, for example, that the value of an IT investment over, say, the next
five years is, in terms of today’s dollars, $2 million more than its $3 million cost. In other words, the $3
million investment is expected to produce an NPV (net gain) of $2 million in terms of today’s dollars.
difference. But there is usually a difference. For example, it is possible to get a 67% return on a $100
project, so telling us that the return will be 67% does not give us enough information. Similarly, the NPV
figure of $2 million does not by itself tell us the rate of return we can expect on the dollars invested. We
need both the ROI and the NPV to get a proper financial picture. When the ROI and NPV are computed
using the same set of data, we will know both the rate of return as well as the total amount of net gain
that will be produced in terms of today’s dollars.
some detail. The cost information as well as insights on risks can be generated through the preparation
of a work breakdown structure for each alternative solution. The economic analysis, using information
from the WBS and its financial documentation for each alternative solution, can be used to identify the
solution expected to generate the best financial return.
the probability that not all of the financial benefits may be realized. Template 6 enabled you to perform
a risk analysis of the alternative solutions. Now the question is how will the risks identified for an
alternative solution (taking into account the planned risk mitigation) likely to affect the benefits
expected from implementing that alternative solution. In general, the effect of risk on the expected
benefits is a matter of informed judgement.
week 5 content area. A separate Economic Analysis is prepared for each alternative solution. In making
entries in a worksheet, decisions need to be made on how each type of expected financial benefit will be
affected by risk in each year of the projected life cycle. These risk-estimate inputs enable the Worksheet
to calculate risk-adjusted benefits over the life cycle of the project.
satisfy. These are important benefits of a satisfactory alternative solution. Each alternative solution must
satisfy these requirements but each alternative solution may have other benefits beyond those new
capabilities or functionalities. These benefits need to be identified and quantified in financial terms. The
financial benefits data can then be entered into the Economic Analysis Worksheet for the life cycle of
the IT system.
cost information generated in the preparation of the work breakdown structures (Template 5). There
are a number of approaches to improving the reliability and validity of cost estimates and projections,
but they are beyond the scope of your present course and this activity. Estimating and projecting cost is
often one of the weakest aspects of IT acquisition planning. Sometimes in the zeal to get a proposal
approved, costs are minimized, overlooked, or hidden in biased and faulty assumptions. Sometimes it is
simply a lack of knowhow. Organizations that implement a professional approach to estimating and
projecting cost benefit in many ways, not the least of which is more effective project management.
entries in the Economic Analysis Worksheets. If a life cycle of three years is used for one alternative
solution, a three-year life cycle must also be used for the other alternative solution.
period over which results can be compared. Usually, this means using the number of years equivalent to
the alternative with the shortest life cycle (often three or four years). However, the selection of the life
when they have their peak payoffs.
alternative has a 4-year life cycle with its peak payoff in years 3 and 4, some will argue that it would not
be fair to use a 3-year period to make a comparison. Could a 4-year or 5-year life cycle period be used
for both alternatives? The answer is yes, but then it will be necessary to provide 4 or 5 years of data for
each of the alternatives. A decision will need to be made to select the number of years that provides
the best comparison, whether it is 3, 4, or 5 years.
One approach is to continue the shorter-life alternative past its operational “Obsolescence” date by
using the year 3 data for year 4 and, if needed, for year 5, with some adjustments if needed. The
adjustments can include any added cost and or changes in the benefits that are likely to occur in years 4
and 5.
period of time.
Workbook contains five worksheets. Worksheets 1, 2, and 3 contain examples of data that were entered
for two alternative solutions. Worksheets 4 and 5 explain how the data were generated for the
alternative solution presented in worksheet 2. You may find this helpful in developing or confirming the
data that you should enter for your two alternative solutions. If you had difficulty determining the costs
for your work breakdown structures, the explanations in worksheet 5 should be especially helpful.
with the data for your own two alternative solutions. The worksheets will calculate automatically, as will
the comparison information on worksheet 1. In other words, the chart and tables on worksheet 1 will
now compare your two alternative solutions based on the information you entered.
cells contain the formulas for calculating the worksheets and this is a way of protecting them from
accidental modification.
worksheets 4 and 5 explain this.
alternative solution will increase maintenance costs by, say, $500 per year for the next three years, that
is the figure you enter. On the other hand, if the maintenance costs will increase by 10% per year over
the next three years, you enter $500 for the first year, $550 for the second year, and $605 for the third
year. The worksheet takes care of all calculations, including adjustments for the time value of money for
these and other entries.
that each type of benefit will actually be received. For example, if an alternative solution is expected to
add $100,000 per year in improved productivity, you would enter the $100,000 and also the percentage
of the $100,000 expected to be actually achieved each year. It could be 70% in the first year after the
project ends and 95% in the subsequent years. You would enter the 70% and the 95% figures in your
worksheet. You need to determine and assign the probability figures (the percentages) based on the risk
analysis you did for each alternative solution. These probabilities are necessary so the worksheet can
produce a risk-adjusted, discounted (by the time value of money) ROI and NPV for your alternative
solution.
There are more sophisticated ways, including the use of Monte Carlo simulations based on probability
distributions (such as the triangular distribution). If you wish, you can do research to obtain more
information about probability distributions and Monte Carlo simulations.
and study the examples. Then it is usually a good idea to enter zeros in all the data cells before you start
entering your own data into a worksheet. This will erase the example in the worksheet and you will
know that all the data entries are your own.
not change these settings, since some instructors print each Workbook for grading. The results of the
Economic Analysis of the two best alternative solutions serve as input to the Template 8 analysis,
which determines which of the two is the most advantageous solution.