INFO2010 - L4 Justifying the system

Question 1

Biz IT

Answer 1

Evolution of computing, became subsumed into whole biz function
Prevalence and benefits of IS/IT often taken for granted by biz orgs
Strategy needed for optimising IT investment to maximise the investment

Question 2

Competitive advantage through IT

Answer 2

• Ability of a biz org to compete with others
• Competitive biz recognises that IS/IT can be used to transform an org’s relation to its customers
• Competitive adv gained by providing superior efficiency, effectiveness and sys sustainability

Question 3

Justifying the investment

Answer 3

Can be transformative of biz practice
Upper management hv pesimistic attitude so peeps want to see a cost justification for IT investment
Sometimes difficult to do

Question 4

Justifying the investment

Answer 4

Acquiring IT can require significant resources
Two clear benefits:
- predict what cost will be incurred, quantify them, match them with predicted benefits
- if quantified benefits outweighs quantified costs, acquisition of IT is justified

Question 5

Capital budgeting

Answer 5

Process of analysing and selecting various proposals for capital expenditure.
CB methods rely on measures of cach flow in and out of org

Question 6

Main reasons for investing into capital projects

Answer 6

• expand production to meet anticipated demand
• to modernise production equipment ot reduce cost
  IS - considered long term capital investment projects

Question 7

Other reasons for investing into capital projects - non economic

Answer 7

Install pollution control equipment
Meet government regs
satisfy non-market public demands

Question 8

Capital budgeting models

Answer 8

Payback method
Acounting ROI on investment
Net Present Value
Cost Benefit Ratio
Profitability Index
Internal Rate of Return

Question 9

Payback method

Answer 9

Measure of time required to pay back the initial investment of a project
Orig Investment
————————– = No of yrs to payback
Annual net cash flow

Question 10

Payback method benefits

Answer 10

Simple
Powerful as an initial screening method
Good for high risk projects where useful life is difficult to know
If sys pays for itself in 2 yrs, less important how long it will last
Ignores (this is weakness as well as virtue):
- time value of money
- amount of cash flow after payback period
- disposal value
- profitability of investment

Question 11

Accounting Rate of Return on Investment

Answer 11

Firms make capital investments to earn a satisfactory rate of return; depends on;

• cost of borrowing money
• historic rates of return expected by the firm
• desired rate of return must equal or exceed the cost of capital in the marketplace

Question 12

Rate of ROI in practice

Answer 12

ROI ralculates the rate of return from an investment by adjusting the cash inflows produced by the investment for depreciation.
Gives an approximation of the accounting income earned by the project
- ignores time value of money; does not need to be converted into present value

Question 13

Rate of ROI in practice - how to work it out

Answer 13

(Total benefits-Total Cost-Depreciation)
—————————————— = Net Benefit
Useful life

Net Benefit
——————————— = ROI
Total Initial Investment

Question 14

Depreciation

Answer 14

Cost of life of equipment usual 20+ years for large plant

ICT much less 10-15 years

Question 15

ROI - how is it used

Answer 15

Projects ranked in descending order by ROI
Those providing acceptable ROI selected
Can be altered by resource constraints, organisational priorities or politics

Question 16

ROI Disadvantages

Answer 16

IS projects do not lend themselves to easy quantification and estimation of costs and benefits.
Costs and benefits of such projects are variable, complex, interrelated and difficult to estimate - often preclude a meaningful ROI analysis.

Question 17

Net Present Value

Answer 17

Value in current £ of a payment or stream of payments to be received in future
£ today worth more than £ in the future
Limitation
- does not provide a measure of profitability
- does not provide a way to rank-order diff pos investments

Question 18

Present Value

Answer 18

Future payments are discounted

Payment
————————– = Present Value
(1 + Interest)^n

n = year

Question 19

Net Present Value

Answer 19

Sum of Present Value of expected cash flows minus Initial investment cost = Net Present Value

N payment
Sum ———————- - Initial Cost = NPV
n=1 (1 + interest) ^n

If NPV

• > 0 invest
• = ) undecided
• < 0 reject

Question 20

Present value

Answer 20

If all cash flows are the same;

             1 - (1 + interest)^-n Payment x ------------------------------ = NPV
                 interest

Question 21

Net Present Value

Answer 21

To compare the investment (made in today’s £) with future savings or earnings, you need to discount the earnings to their present value and then calculate the NPV of the investment.
NPV is the amount of money and investment is worth, taking into account its cost, earnings and the time value of money.

Question 22

Cost Benefit Ratio

Answer 22

Simple method to calculate the returns from a capital expenditure which is the ratio of benefits to costs

Total benefits
——————————– = C-B Ratio
Costs

Question 23

C-B Ratio is used

Answer 23

To rank several projects for comparison
Some orgs establish a minimum C-B Ratio that must be attained by capital projects.
Can also be calculated by using Presnet Values to account for the time value of money.

Question 24

Profitability index

Answer 24

Projects can be rank-ordered on this index, permitting firms to focus only on the most profitable projects.

Present cash value of inflows
——————————————— = Prof indx
Investment

Question 25

Internal rate of return

Answer 25

Variation on the net present value method
- takes into account the time value of money
- IRR defined as the rate of return or profit that an investment is expected to earn
IRR is the discount (interest) rate that will equate the present value of the project’s future cash flows to the initial cost.
Value of R (discount rate) is such that
Present Value - Initial cost = 0

Question 26

Summary

Answer 26

Investment in IT Sys different benefits for diff orgs;
- allowing an org just to survive in a global market
- improving the corporate image as a leader in their field
IT should be seen in the context of an overall competitive strategy:
- all change will involve cost
- it costs not to change/stand still
Important benefit of investment in IT relates to the organisation’s market position and the income generated from that position.