Cost/Benefit AnalysisReference: 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.
Hardware 2. Personals 3. Facility cost 4. Operating cost 5. Supply
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 benefits
1. 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 benefits1. Tangible or Intangible
costs and benefits: Benefits are also classified as tangible on
intangible. Management often ignore intangibles this may lead to
Classification of Cost and benefits2. 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 benefits3. 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
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
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
Numerical based on Present value AnalysisQ. 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
4. Payback Analysis Payback formula: Elements of the formula:A.
B. C. D. E. F. G. H. Capital investment(development cost).
Investment credit difference(tax incentive). Cost investment(site
preparation). Company federal income tax bracket difference. State
and local tax. Life of capital. Time to install the system. Benefit
4. Payback Analysis Elements of the formula:1. 2. 3. 4. 5.
Project benefits(H). Depreciation (A/F) State and local tax (A X
E). Benefit from Federal Income Tax (FIT): 1 2 3 = 4 Benefits after
FIT: 4 (4 X D)
Payback Analysis Numerical ExampleA. B. C. D. E. F. G. H.
Capital investment=$200,000 Investment credit
difference(100%-8%)=92%. Cost investment=$25000. Company federal
income tax bracket difference (100%-46%)=54% State and local tax=
2%. Life of capital= 5 Years. Time to install the system = 1 years.
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 ExampleReven Jan ue Feb Mar Apr May June
July Aug Sep Oct Nov Dec Reven 22000 22000 26000 27100 41000 48000
59050 59010 66450 64040 69700 71040 ue Expen 51175 34795 27805
27055 28445 28385 29640 29925 28030 30075 30015 30906 se Cash flow
Accu mulat ed cash flow -1805 29175 12795 45 12555 19615 29410
30085 22420 33965 39685 40134
29175 41970 43775 43730 31180 11565 17845 47930 70350 10431
14400 18413 5 0 4