cost benfit

Cost/Benefit Analysis

Reference:System Analysis and Design (Chapter 8)

By Elias M. Awad

Data Analysis

• The system requirements are:1. Better customer service.2. Faster information retrieval.3. Quicker notice preparation.4. Better billing accuracy.5. Lower processing and operating cost.6. Improve staff efficiency.7. Consistent billing procedure to eliminate error.

Data Analysis

• Several alternative must be evaluated.• The approach can introduction of computer

billing system, change in operation procedure, replacement of staff, improve billing system or combination of this approach.

Cost and benefit categories

• In developing cost estimate for a system, we need to consider the following cost elements:

1.Hardware2.Personals3.Facility cost4.Operating cost5.Supply cost

Procedure for cost/benefit determination

• Cost and benefit analysis procedure that gives a picture of various cost, benefits, and rules associated with a system

• Determination of cost and benefits uses the following steps:

1. Identifying the cost and benefit pertaining to a given project.

2. Categorize the various costs and benefits for analysis.3. Select a method for evaluation.4. Interpreted the result of analysis.5. Take action.

Procedure for Cost/Benefit Determination

• Cost and benefit identification: – Certain cost and benefits easily identify than

other. Example:- Direct cost.– Categories of cost or benefits that is not easily

identifiable is opportunity costs and benefit.

Classification of Cost and benefits

• The next step is to categorize cost and benefits1. Tangible or Intangible costs and benefits:• Tangibility refers to the easy with which cost

or benefit can be measure. • Expenditure of cash for specific item or

activity is known as tangible cost. • Cost that are known to exist but whose

financial value cannot be accurately measured are known as intangible cost.

Classification of Cost and benefits

1. Tangible or Intangible costs and benefits:• Benefits are also classified as tangible on

intangible.• Management often ignore intangibles this

may lead to unexpected outcome.

Classification of Cost and benefits

2. Direct or Indirect Cost and Benefits:• Direct cost are those with which a dollar figure

can be directly associated in the project.• Direct benefits also can be specifically

attributable to a given project.• Indirect cost are the results of operations that

are not directly associated with a given system or activity.

• Indirect benefits are realized as a bi product of another activity or system.

Classification of Cost and benefits

3. Fixed or Variable:Fixed cost are constant they do not change.Variable cost incurred on regular basis and they

are proportional to work volume.Fixed benefits are constant they do not change.Variable benefit realized on regular basis.

Saving versus Cost Advantage

• Saving are realized when there is some kind of cost advantage. Cost advantage reduce or eliminates expenditure.

• True saving reduce or eliminates various cost being incurred.

• There are also saving that do not directly reduce the existing cost.

Select Evaluation Method

• The common evaluation methods are:1.Net benefit analysis.2.Present value analysis.3.Net present value.4.Payback analysis.5.Break even analysis.6.Cash-flow analysis.

1. Net benefit analysis

• Net benefit= (Total benefit)- (Total cost)• Advantage: Easy to calculate, easy to interpret

and easy to present.• Disadvantage: It does not account for time

value of money.• Time value of money is express as:

2. Present value Analysis

• Present value analysis calculate the cost and benefits of the system in terms of today's value of the investment.

Numerical based on Present value Analysis

Q. Suppose that $3,000 is to be invested in a project, and the expected annual benefit is $1,500 for four year life of the system. Determine the expected profit or loss.

3. Net Present Value

• Net Present value:

• The net present value is express as percentage of investment.

• This approach is relatively easy to calculate and accounts for the time value of money.

4. Payback Analysis

• It tells you how long it will take to earn back the money you'll spend on the project.

• The shorter the payback period, sooner a profit is realized and more attractive is the investment.

4. Payback Analysis• Payback formula:

• Elements of the formula:A. Capital investment(development cost).B. Investment credit difference(tax incentive).C. Cost investment(site preparation).D. Company federal income tax bracket difference.E. State and local tax.F. Life of capital.G. Time to install the system.H. Benefit and saving.

4. Payback Analysis

• Elements of the formula:1. Project benefits(H).2. Depreciation (A/F)3. State and local tax (A X E).4. Benefit from Federal Income Tax (FIT): 1–2–3 = 45. Benefits after FIT: 4 – (4 X D)

Payback Analysis Numerical Example

A. Capital investment=$200,000B. Investment credit difference(100%-8%)=92%.C. Cost investment=$25000.D. Company federal income tax bracket difference

(100%-46%)=54%E. State and local tax= 2%.F. Life of capital= 5 Years.G. Time to install the system = 1 years.H. Benefit and saving = $250,000.

5. Break even Analysis

• Break even is the point where the cost of the candidate system and that of the current one are equal.

• When a candidate system is developed, initial costs usually exceed those of the current system. This is the investment period.

• When both are equal its break point.• Beyond break point the candidate system provide

more benefit than the old one-return point.

6. Cash flow Analysis

• Cash flow analysis keep track of accumulated cost and revenues on a regular basis.

• The spread sheet format also provide payback and break point information.

Cash flow Analysis an ExampleRevenue

Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec

Revenue

22000 22000 26000 27100 41000 48000 59050 59010 66450 64040 69700 71040

Expense

51175 34795 27805 27055 28445 28385 29640 29925 28030 30075 30015 30906

Cash flow

-29175

-12795

-1805 45 12555 19615 29410 30085 22420 33965 39685 40134

Accumulated cash flow

29175 41970 43775 43730 31180 11565 17845 47930 70350 104315

144000

184134