Systems Analysis and Design Fourth Edition Introduction  A project is economically feasible if the future benefits outweigh the costs  The Systems Analyst’s Toolkit explains how to calculate a project’s costs and benefits  Cost-benefit analysis is performed when  Conducting a preliminary investigation  Evaluating a project  Making recommendations to management

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Cost classifications  Costs can be classified in several ways  Tangible and intangible costs  Direct and indirect costs  Fixed and variable costs  Developmental and operational costs

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Direct and indirect costs  Direct costs are those that can be associated with the development of a specific system  Examples: project team salaries, new hardware or software needed for the system  Indirect costs, or overhead expenses, cannot be attributed to a particular system  Examples: network administrator’s salary, copy machine rental costs

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Fixed and variable costs  Fixed costs are relatively constant and do not depend on a level of activity or effort  Examples: salaries, rental charges  Variable costs depend on the level of activity  Examples: printer paper, supplies, telephone line charges

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Developmental and operational costs  Development costs are incurred only once, at the time the system is developed  Examples: system development team salaries, user training, hardware purchase  Operational costs are incurred after the system is implemented and continue while the system is in use  Examples: system maintenance, ongoing training, annual license fees

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Managing information systems costs and charges  Management requires cost information  Direct costs can be associated with a specific system, while indirect costs must be allocated  A chargeback method uses accounting entries to allocate the indirect IS costs  No charge method  Fixed charge method  Variable charge method based on resource use  Variable charge method based on volumes

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Managing information systems costs and charges  Chargeback methods  No charge method  Treats IS department indirect expenses as a necessary cost of doing business, which benefits the entire company  The IS group is called a cost center because it generates no offsetting credits for services performed  User departments are not charged for indirect IS expenses

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Managing information systems costs and charges  Chargeback methods  Fixed charge method  Indirect IS costs are divided among all other departments in the form of a fixed monthly charge, using various formulas  In this method, the IS group is called a profit center because it is expected to break even or show a profit on the sale of services  User departments are charged with a fixed share of indirect IS expenses

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Managing information systems costs and charges  Chargeback methods  Variable charge method based on resource use  Resources might include CPU time, connect time to a remote computer, communication lines or printers required  Costs can vary from month to month  In this method, the IS group is called a profit center  User departments are charged with indirect IS expenses on the basis of resources used

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Managing information systems costs and charges  Chargeback methods  Variable charge method based on volume  Resources might include CPU time, connect time to a remote computer, communication lines or printers required  Costs can vary from month to month  In this method, the IS group is called a profit center  User departments are charged with indirect IS expenses on the basis of resources used

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Benefit classifications  Benefits can be classified into the same categories as costs  Tangible and intangible benefits  Direct and indirect benefits  Fixed and variable benefits  Developmental and operational benefits  Benefits also can be classified as positive benefits and cost-avoidance benefits

Systems Analysis and Design Fourth Edition Describing Costs and Benefits  Positive and cost-avoidance benefits  Positive benefits are a direct result of the new information system  Examples: increased revenues, improved services, higher morale, better management  Cost-avoidance benefits refer to expenses that would be necessary if the new system is not installed  Examples: handling work with current staff instead of hiring, not having to replace hardware or software

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Cost-benefit analysis is the process of comparing anticipated costs to anticipated benefits  Cost-benefit analysis produces reliable information for making decisions  Common cost-benefit techniques  Payback analysis  Return on investment (ROI) analysis  Present value analysis

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  Payback analysis is the process of determining how long it takes for an information system, to pay for itself  Four step process 1. Determine the system’s initial development cost 2. Estimate annual benefits 3. Determine annual operating costs 4. Find the payback period by comparing total costs to accumulated benefits Click to see Figure 2-1

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  When costs and benefits are plotted, the economically useful life of the system is shown  Systems development costs are high at first, then drop  Systems operation costs remain low until increased maintenance is required toward the end of the system’s economically useful life

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  When costs are plotted, the economically useful life of the system is shown  Systems development costs are high at first, then drop  Operational costs remain low at first, then increase as more maintenance is required Click to see Figure 2-2

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  When costs are plotted, the economically useful life of the system is shown  Systems development costs are high at first, then drop  Operational costs remain low at first, then increase as more maintenance is required  Benefits usually increase rapidly when the system becomes operational, then level off Click to see Figure 2-3

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  When costs and benefits are plotted on the same graph, the payback period is illustrated  Note that the payback period is not the point where the current benefits equal current costs  The payback period is the point where accumulated benefits equal accumulated costs Click to see Figure 2-4

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Payback analysis  Pros and cons  Payback analysis emphasizes costs and benefits early in the system’s life and ignores those that occur later  Even though it has drawbacks, payback analysis is widely used

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Using a spreadsheet to compute payback analysis  Design the spreadsheet and label the rows and columns  Enter the cost and benefit data for each year  Enter the formulas to calculate cumulative costs and benefits Click to see Figure 2-6 Click to see Figure 2-5

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Return on investment analysis  ROI is a percentage rate that measures profitability by comparing a project’s total net benefits (the return) to its total costs (the investment)  ROI = (total benefits - total costs) / total costs  Projects can be ranked using ROI Click to see Figure 2-7

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Return on investment analysis  Pros and cons  ROI does consider all costs and benefits during the system’s life, and is a more precise method than payback analysis  ROI only measures the overall rate of return for the total period, and annual rates can vary considerably  ROI ignores the timing of costs and benefits

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Using a spreadsheet to compute ROI  Set up the worksheet and enter cost and benefit data  Overall cost and benefit totals are required  Add a formula to calculate ROI, which is total benefits minus total costs, divided by total costs Click to see Figure 2-8

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Present value analysis  The time value of money is a concept that adjusts future costs and benefits and expresses them in terms of current dollars  The timing of costs and benefits directly affects the desirability of a project  Benefits that you receive now are more valuable than those you receive in the future, because you gain the use of the money and can invest it  Costs that you incur now are more expensive than those you incur in the future, because you lose the use of the money immediately

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Present value analysis  Present value adjustment factors are based on a specified interest rate called the discount rate  The discount rate is the return a company might expect on a risk-free investment, such as a bond  Each company determines its own acceptable rate of return for an information systems project  Adjustment factors are printed in tables called present value tables, which are readily available Click to see Figure 2-9

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Present value analysis 1. Use present value tables to time-adjust values  Locate the adjustment factor in the column with the appropriate discount rate and the row for the appropriate number of years  Multiply this value times the costs and benefits to calculate the adjusted cost and benefit values Click to see Figure 2-10

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Present value analysis 1. Use present value tables to time-adjust values  Locate the adjustment factor in the column with the appropriate discount rate and the row for the appropriate number of years  Multiply this value times the costs and benefits to calculate the adjusted cost and benefit values 2. Total the time-adjust costs and benefits 3. The net present value (NPV) is total benefits minus total costs Click to see Figure 2-11

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Present value analysis  Pros and cons  Present value analysis not only considers all costs and benefits, but adjusts the values based on timing  NPV results depend on future estimates, and are only as reliable as the forecasts themselves  Many companies use all three methods to evaluate projects

Systems Analysis and Design Fourth Edition Cost-Benefit Analysis  Using a spreadsheet to calculate present value  Set up the worksheet and enter costs, benefits, and present value adjustment factors  Provide cost and benefit totals  Add formulas to multiply each cost and benefit value times the appropriate adjustment factor  Add a formula to calculate net present value (NPV), which is total adjusted benefits minus total adjusted costs Click to see Figure 2-12

End Toolkit Part 2