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# ROI, NPV and PP

## by Rahmad Kurniawan, Lecturer Of Informatics Engineering at UIN Sultan Syarif Kasim Riau on Mar 24, 2013

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## ROI, NPV and PPPresentation Transcript

• ASSALAMU’ALAIKUM INFORMATION TECHNOLOGY MANAGEMENT ROI, NVP, AND PAYBACK PERIODReturn on Investment, Net Present Value and Payback Period Disajikan Oleh : RAHMAD KURNIAWAN P68500
• Contents1. ROI2. NPV 1. NPV on “Chapter 17, Exercises and Project, No.2”3. Payback Period 2 RAHMAD KURNIAWAN P68500
• What is ROI?ROI can be defined as:  One of several approaches to building a financial business case (Solution Matrix).  A performance measure used to evaluate the efficiency of an investment.  A performance measure to compare the efficiency of different investments.  ROI is a metric that yields some insights into how to improve business results in the future (L. Dombrowski) 3 RAHMAD KURNIAWAN P68500
• Cont... Another traditional tool for evalating capital investments is return on investment (ROI), which measures the effectiveness of management in generating profits with its available assets. (Turban) The ROI measure is a percentage, and the higher this percentage return, the better. It is calculated essentially by dividing net income attributable to a project by the average assets invested in the project. 4 RAHMAD KURNIAWAN P68500
• Simple ROIThe benefit (return) of an investment is divided by the cost of the investments. The result is expressed as a percentage or a ratio. This is referred to as “simple ROI”. ROI= Gains from investment – Cost of investment Cost of Investment \$700,000 - \$500,000 = 40% \$500,000 5 RAHMAD KURNIAWAN P68500
• Example of ROIFor example, a \$1000 investment that earns \$50 in interest obviously generates more cash than a \$100 investment that earns \$20 interest, but the \$100 investment earns a higher return.So... 6 RAHMAD KURNIAWAN P68500
• Cont... \$1050 \$1000 \$50ROI \$50 / 1000 5% \$1000 \$1000 \$120 \$100 \$20ROI \$20 / 100 20% \$100 \$100 7 RAHMAD KURNIAWAN P68500
• What is NPV?NPV can be defined as:  NPV is one of Capital budgeting analysis uses standard financial models. (Turban)  Net present value is the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project.If NPV > 0, acceptIf NPV < 0, reject 8 RAHMAD KURNIAWAN P68500
• Cont...Organizations often use net present value (NPV) calculations for cost benefit analyses.In an NPV analysis, analysts convert future values of benefits to their present-value equivalent by discounting them at the organization’s cost of funds. 9 RAHMAD KURNIAWAN P68500
• NPV Formula C1 C2 CT NPV C0  (1 r )1 (1 r ) 2 (1 r ) T Where,  r is the target rate of return per period;  C0 is the Initial investment.  C1 is the net cash inflow during the first period;  C2 is the net cash inflow during the second period;  C3 is the net cash inflow during the third period, and so on ... 10 RAHMAD KURNIAWAN P68500
• Example of NPVThere is an opportunity to invest in a business that will pay \$200,000 in one year, \$400,000 in two years, \$600,000 in three years and \$800,000 in four years. It can earn 12% per year compounded annually on a mutual fund that has similar risk. If it costs \$1.2 million to start this business, should be invest?So... 11 RAHMAD KURNIAWAN P68500
• Cont...0 1 2 3 4 years| | | | || | | | |CF –\$1.2 mil \$200,000 \$400,000 \$600,000 \$800,000 Discount rate = 12% C1 C2 CT NPV C0  (1 r )1 (1 r ) 2 (1 r ) T 200,000 400,000 600,000 800,000 NPV 1,200,000 (1.12)1 (1.12) 2 (1.12) 3 (1.12) 4 = \$232,932 12 RAHMAD KURNIAWAN P68500
• Resources of data based on exercisesNo. 2 Investing \$ 15.000.000 Revenue year 1 \$ 4.000.000Cost, Year 1 \$ 2.000.000 Revenue, year 2 \$ 5.000.000Cost, Year 2 \$ 2.000.000 Revenue, year 3 \$ 5.000.000Cost, Year 3 \$ 1.500.000 Revenue, year 4 \$ 5.000.000Cost, Year 4 \$ 1.500.000 Revenue year 5 \$ 5.000.000Cost, Year 5 \$ 1.500.000 Total \$ 24.000.000 Total \$ 23.500.000 Interest rate 10% Assumed first year include investment and cash flow year 1 \$ (13.000.000) cost cash flow year 2 \$ 3.000.000 cash flow year 3 \$ 3.500.000 cash flow year 4 \$ 3.500.000 cash flow year 5 \$ 3.500.000 NPV= \$ (2.145.469,45) 13 RAHMAD KURNIAWAN P68500
• What is Payback Period?Payback Period can be defined as:  Number of years needed to recover the initial cash outlay of a projectComputation  Estimate the cash flows  Subtract the future cash flows from the initial cost until the initial investment has been recoveredDecision Rule – Accept if the payback period is less than some preset limit 14 RAHMAD KURNIAWAN P68500
• Example of PaybackExample: Project with an initial cash outlay of \$10,000 Free Cash Flows of \$2,500 per year for 6 years Year Cash Flow Balance \$10,000 1 \$2,500 \$7,500 2 \$2,500 \$5,000 3 \$2,500 \$2,500 4 \$2,500 --------Payback is 4 years 15 RAHMAD KURNIAWAN P68500
• References Turban, McLean, Wetherbe. Information Technology for Management: Transforming Organizations in the Digital Economy (4th edition) Turban, Volonin, Wood. (2012). Information Technology for Management, 8th edition. John Wiley & Sons (Asia) Pte Ltd. http://www.cwu.edu/ http://www.passitoncenter.org http://business.fullerton.edu 16 RAHMAD KURNIAWAN P68500
• Thank you17 RAHMAD KURNIAWAN P68500