Cost-Benefit and analysis -Tools and techniques
COST BENEFIT ANALYSIS
Costs fall into two categories. There are cost associated with developing the systems and there are costs associated with a operating a system. The former can be estimated from the outset of a project and should be refined at the end of each of each phase of the project. The latter can be estimated only after specific computer-based solution have been defined. Let’s take the closer look at the costs of information systems. The costs of developing an information system can be classified according to the phase in which they occur.
System development costs are usually one time costs that will not recur after the project has been completed. Many organizations have standard cost categories that must be evaluated. In the absence of such categories, the following list should be of help:
- Personnel costs. The salaries of system analysts, programmers, consultants, data entry, Personnel, computers operators, secretaries, and the like who work on the project being estimated.
- Computer usage. Computer time will be used for one or more of the following activities: programming, testing conversion, word processing. Maintaining a project dictionary, prototyping, loading a new data file, and the likes . If a computing center charges for usage of computer resources such as disk storage or report printing, the cost should be estimated.
- Training. If the computer personnel or end-user have to be trained, the training courses may incur expenses. Packaged training courses may be charged out on a flat fee per site, a student fee or an hourly fee.
- Supply duplications, and equipment costs.
- Costs of any new computer equipment and software.
Almost nobody forgets system development budgets when itemizing costs. On the other hand, it is easy to forget that a system will incur costs after it is operating. The lifetime benefits must recover both the development and operating costs. unlike system development costs, operating costs tend to recur throughout the lifetime of the system. The costs of operating a system over its useful lifetime can be discussed below.
Present Value Analysis
Here the present value of the costs and benefits of the future periods is used to compare and so the analysis. For this “present value” computation discounting is done to compare the money with what would have been earned if the money was put in some other projects.
Suppose a benefit of Rs. 1000 is expected at the end of one year. The current annual interest rate is 10%.The future benefit of Rs. 1000 is therefore equivalent to the value of Rs. 1000 or an amount of Rs. 908 today is equivalent to Rs. 1000 a year later.
A tabulation of present values is based on 12% interest. This analysis is used for such discounting for each future value to obtain the total present value of the benefits. It also shows that the present value of stream of future values of Rs. 1000 each for the next 6 year after discounting for 12% is Rs.4111.41.
Net present value
The present value analysis when carried out for the net benefits is called the net present value or NPV. Time value of money is used for both costs and benefits. The analysis of the example in net benefits done using present value is shown in the table below.
When any project is started, many of the costs are incurred in the beginning while the benefits take time to start getting realized. Payback analysis is to determine when the accumulated benefits equal the initial investment. This period is called payback period. The shorter the period the faster the profits of the new system start to flow, and the more attractive the project seems.
This analysis may be done with or without taking into account the time value of money. Different payback periods may be obtained depending on whether or not the time value of money is taken into account. Table below shows an example of payback analysis.
Break-even analysis compares the costs of the current system to the new system. A new system has a larger investment in the beginning- over time, benefits start coming in. on the other hand for the current existing system, the costs are mainly the operational costs. The cost per transaction will be lower than that the old system beyond some volume. This is called the beak-even point. Below this volume the old system is less costly while above this volume the new system is less costly.
A is an existing system with a steady costs of Rs. 4 per transaction while system B is a proposed a new system with a initial costs of Rs. 15000 and a transaction processing cost of Rs.1 per transaction after that. The break-point is reached at a transaction volume of 5000.
Cash Flow Analysis
Cash flows out when money is spent and is received with revenues and earnings. By tabulating both the out flow and the inflow of cash expected over a period of time a clear picture is obtained. The plot of the accumulated flow gives the payback period and a break point. It also gives an idea of how much cash will be needed to get the new system going. The point where the accumulated cash flow turns positive is the pay back period.