Cost-Benefit Analysis

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Cost-Benefit Analysis

  1. 1. COST - BENEFIT ANALYSIS
  2. 2. Concept of Cost – Benefit Analysis <ul><li>The ultimate aim of a business organization is to make profits. </li></ul><ul><li>Therefore, any system in the organization must produce more </li></ul><ul><li>benefits as compared to its costs for the organization to survive & </li></ul><ul><li>prosper. </li></ul><ul><li>MIS must yield higher benefits than the costs. For this, cost –benefit </li></ul><ul><li>analysis (CBA) is important. </li></ul>BENEFITS > COSTS
  3. 3. <ul><li>What is Cost - Benefit Analysis? </li></ul><ul><li>CBA has been established primarily as a tool for use by governments in making their social and economic decisions. </li></ul><ul><li>CBA measures costs and benefits to the community of adopting a particular course of action e.g. Constructing a dam, by-pass etc. </li></ul><ul><li>CBA is a decision making device for evaluating activities that are not priced by the market. </li></ul><ul><li>CBA attempts to simulate a market result in areas where the market does not operate to establish prices. </li></ul><ul><li>Or attempts to quantify and include in estimates of cost and benefits to client but also to rest of community. </li></ul>
  4. 4. Cost Benefit Analysis <ul><li>Decision making is about choices </li></ul><ul><li>For an individual </li></ul><ul><ul><li>They might rely on intuition, a “gut feel” for the right choice. They decide to do an analysis of the choices or it may be a combination of both of these. </li></ul></ul><ul><li>For a company </li></ul><ul><ul><li>Being concerned with the profit earning capacity and income flow, they may undertake a cash flow analysis or a full financial appraisal of the project. </li></ul></ul><ul><li>For the Government </li></ul><ul><ul><li>Decision making for governments is much harder. Not only are they expected to consider the profitability (or at least neutrality) of the costing but must also include consideration of the social cost and benefits of their choices. They are also expected to act within the political environment to satisfy the political agenda set by the government of the day and finally, must also comply with environmental considerations. </li></ul></ul>
  5. 5. Cost – Benefit Analysis <ul><li>Other issues </li></ul><ul><li>Is the project worthwhile financially? </li></ul><ul><li>Is it the best option? </li></ul><ul><li>Should it be undertaken at all? </li></ul>
  6. 6. Process of Cost – Benefit Analysis : - <ul><li>CBA is a process that presents a picture of various costs & </li></ul><ul><li>benefits associated with an information system. </li></ul><ul><li>CBA as a process consists of 3 basic activities viz. </li></ul><ul><ul><li>1 . Identification of Costs & Benefits : </li></ul></ul><ul><li>Identify the costs & benefits associated with a task/operation, or investment project. </li></ul>Identification of costs & benefits Evaluation of costs & benefits Choice of System
  7. 7. <ul><li>2 . Evaluation of costs ( tangible, intangible, fixed, variable, direct, & indirect) & benefits associated with each task/operation/investment project. </li></ul><ul><li>Choice of system : Select the best system which involves least cost & yields maximum benefits. </li></ul>
  8. 8. Costs & Benefits of Information Systems COSTS BENEFITS Hardware Tangible Telecommunications Increased Productivity Software Low Operating Costs Personnel Reduced Workforce Lower Computer Costs Accessories : Lower Outside Vendor Costs Computer Forms Reduced rate of growth in expenses Computer ink/ribbon Reduced Facility Costs UPS Intangible Improved Organizational Planning Services : Increased Organizational Flexibility Insurance Improved Decision making
  9. 9. Maintainance Improved Operations Improved Asset Utilisation Physical Facilities : Enhanced Employee Morale Building Increased Job Satisfaction Furniture Higher Customer Satisfaction Improved Organizational Image
  10. 10. <ul><li>Establishing a steel production plant in a port community </li></ul><ul><li>Costs (-) </li></ul><ul><li>construction. </li></ul><ul><li>pollution. </li></ul><ul><li>devaluing house prices etc. </li></ul><ul><li>Benefits (+) </li></ul><ul><li>employment </li></ul><ul><li>Increased port trade </li></ul><ul><li>steel for local industry </li></ul>Cost – Benefit Analysis
  11. 11. Cost - Benefit Analysis <ul><li>Method </li></ul><ul><li>Identify all possible alternatives. </li></ul><ul><li>Prepare table showing life of the project i.e. year to year basis. </li></ul><ul><li>Establish Cost of project during the year including capital, operating and maintenance costs, social and other tangible costs </li></ul><ul><li>Establish total benefits to be obtained from project by way of sales of goods and services including value of social benefits. </li></ul><ul><li>Cost calculated at rate of interest such that NPV = Zero </li></ul><ul><li>Ranking in order of [ benefit – cost ] or [ benefit / cost ] </li></ul>
  12. 12. Cost - Benefit Analysis <ul><li>CBA unlikely to be a useful </li></ul><ul><li>technique unless two main </li></ul><ul><li>conditions are met : </li></ul><ul><li>Investment must be sufficiently large or important to merit time and cost of CBA. </li></ul><ul><li>Social and other intangible costs and/or benefits must be prospectively and sufficiently large for selection by cost-in-use or investment appraisal to be invalid. </li></ul>
  13. 13. CBA via Portfolio Analysis for Information System <ul><li>Project Risk </li></ul><ul><li>High Low </li></ul><ul><li>High </li></ul><ul><li>B </li></ul><ul><li>E </li></ul><ul><li>N </li></ul><ul><li>E </li></ul><ul><li>F </li></ul><ul><li>I </li></ul><ul><li>T </li></ul><ul><li>S </li></ul><ul><li>Low </li></ul>Cautiously Examine Identify & Develop Avoid Routine Projects
  14. 14. CBA via Profitability Index for Information System <ul><li>CBA via Dividend Payback Period </li></ul>Profitability Index = PV of Cash inflows Investment Payback Period = Total Initial Investment Discounted Annual Cash inflow
  15. 15. CBA via Accounting Rate of Return for Information System Accounting Rate of Return = Average Net Return Total Initial Investment
  16. 16. Problems Associated with CBA <ul><li>Measurement Problems </li></ul><ul><li>Difficulties encounter in measuring intangible costs such as foul atmosphere or intangible benefits such as a peaceful neighbourhood. </li></ul><ul><li>Assuming several other costs & benefits associated with the activities; and estimating the costs and benefits involves. </li></ul><ul><li>Affects by Market condition, state of economy etc. </li></ul><ul><li>Uneven distribution of benefit to the community. </li></ul>
  17. 17. <ul><li>Time Problems </li></ul><ul><li>Tackling future time problems by discounting future costs and benefits. </li></ul><ul><li>Or calculating the correct rate for future rupees value as well as accounting for additional benefits and costs associated. </li></ul>

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