COST - BENEFIT ANALYSIS

Concept of Cost – Benefit Analysis

The ultimate aim of a business organization is to make profits.

Therefore, any system in the organization must produce more

benefits as compared to its costs for the organization to survive &

prosper. MIS must yield higher benefits than the costs.

For this, cost –benefitanalysis (CBA) is important.

BENEFITS > COSTS

3

What is Cost - Benefit Analysis?

CBA has been established primarily as a tool for use by governments in making their social and economic decisions.

CBA measures costs and benefits to the community of adopting a particular course of action e.g. Constructing a dam, by-pass etc.

CBA is a decision making device for evaluating activities that are not priced by the market.

CBA attempts to simulate a market result in areas where the market does not operate to establish prices.

Or attempts to quantify and include in estimates of cost and benefits to client but also to rest of community.

Cost Benefit Analysis

4

Decision making is about choices

For an individualThey 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.

For a companyBeing concerned with the profit earning capacity and

income flow, they may undertake a cash flow analysis or a full financial appraisal of the project.

For the GovernmentDecision 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.

Cost – Benefit Analysis

5

Other issues Is the project worthwhile financially? Is it the best option? Should it be undertaken at all?

Process of Cost – Benefit Analysis : -

CBA is a process that presents a picture of various costs &

benefits associated with an information system.CBA as a process consists of 3 basic activities viz.

1 . Identification of Costs & Benefits :

Identify the costs & benefits associated with a task/operation, or investment project.

Identification of costs &

benefits

Evaluation of costs & benefits

Choice of System

2 . Evaluation of costs ( tangible, intangible, fixed, variable, direct, & indirect) & benefits associated with each task/operation/investment project.

3.Choice of system : Select the best system which involves least cost & yields maximum benefits.

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

Maintainance Improved Operations

Improved Asset Utilisation

Physical Facilities : Enhanced Employee Morale

Building Increased Job Satisfaction

Furniture Higher Customer Satisfaction

Improved Organizational Image

10

Establishing a steel production plant in a port community

Costs (-)construction.pollution.devaluing house prices etc.Benefits (+)employmentIncreased port tradesteel for local industry

Cost – Benefit Analysis

Cost - Benefit Analysis

11

MethodIdentify all possible alternatives.Prepare table showing life of the project i.e. year to

year basis.Establish Cost of project during the year including

capital, operating and maintenance costs, social and other tangible costs

Establish total benefits to be obtained from project by way of sales of goods and services including value of social benefits.

Cost calculated at rate of interest such that NPV = Zero

Ranking in order of [ benefit – cost ] or [ benefit / cost ]

Cost - Benefit Analysis

12

CBA unlikely to be a usefultechnique unless two main

conditions are met :

Investment must be sufficiently large or important to merit time and cost of CBA.

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.

CBA via Portfolio Analysis for Information System Project Risk High

LowHigh

BENEFITS

Low

Cautiously Examine

Identify & Develop

Avoid Routine Projects

CBA via Profitability Index for Information System

CBA via Dividend Payback Period

Profitability Index = PV of Cash inflows Investment

Payback Period = Total Initial Investment Discounted Annual Cashinflow

CBA via Accounting Rate of Return for Information System

Accounting Rate of Return = Average Net Return

Total Initial Investment

Problems Associated with CBA

16

Measurement ProblemsDifficulties encounter in measuring

intangible costs such as foul atmosphere or intangible benefits such as a peaceful neighbourhood.

Assuming several other costs & benefits associated with the activities; and estimating the costs and benefits involves.

Affects by Market condition, state of economy etc.

Uneven distribution of benefit to the community.

17

Time ProblemsTackling future time problems by

discounting future costs and benefits.Or calculating the correct rate for

future rupees value as well as accounting for additional benefits and costs associated.