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ROI, NPV and PP

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  • 1. ASSALAMU’ALAIKUM INFORMATION TECHNOLOGY MANAGEMENT ROI, NVP, AND PAYBACK PERIODReturn on Investment, Net Present Value and Payback Period Disajikan Oleh : RAHMAD KURNIAWAN P68500
  • 2. Contents1. ROI2. NPV 1. NPV on “Chapter 17, Exercises and Project, No.2”3. Payback Period 2 RAHMAD KURNIAWAN P68500
  • 3. 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
  • 4. 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
  • 5. 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
  • 6. 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
  • 7. Cont... $1050 $1000 $50ROI $50 / 1000 5% $1000 $1000 $120 $100 $20ROI $20 / 100 20% $100 $100 7 RAHMAD KURNIAWAN P68500
  • 8. 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
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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
  • 13. 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
  • 14. 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
  • 15. 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
  • 16. 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
  • 17. Thank you17 RAHMAD KURNIAWAN P68500