TECHNOLOGY JUSTIFICATION MODELS Pertemuan 15-16 Matakuliah: A0814/Investment Analysis Tahun: 2009

TECHNOLOGY JUSTIFICATION MODELS Pertemuan 15-16

Matakuliah : A0814/Investment AnalysisTahun : 2009

Technology Justification Models• Understanding the technology justification models

can make the difference between anecdotal support and objective evidence of the business value of IT investment

• The purpose of the justification models is to convert the relationship between IT investment and anticipated payoff into a logical or mathematical form, while accounting for other factors that might affect the measurement along the way.

Bina Nusantara University 3

• The objective of a model is to isolate the surplus profits that can be attributed to the investment.

• The complexity of models increases as other facotrs are added on to either the cost or benefit side of the equation.

• Justification models may be more appropriate given various organizational imperative such as upgrading existing technology, investing in IT infrastructure, and acquiring new IT applications.


Some of Justification Models• Intuition-based models• Cost-benefits analyses• Break-even point• Net present value (NPV)• Economic value added (EVA)• Regression-based statistical models


• The payoff justification is driven by a desire to satisfy an internal realtions need rather than any real concern for IT investment.

• “appearance” factors, focus groups consisting of a cross-section of client individuals can provide the public relations exposure as well as useful feedback of what they perceive as importan. – Focus groups can help guide the IT payoff process toward

identifying the key variables that should be captured for costs as well as benefits.


• Logical or intuition-based models– Represent the relationship between cost and benefit in a

mathematical or graphical format and are widely used to examine the benefits from an investment as well as to determine the time to recoup the investment.


Cost Benefit AnalysisIT Payoff = [Savings (in hours) for all problem

resolution x Average hourly wage rate] – Cost of help desk implementation

P=[∑(Hb – Ha) x W)] – [Ch + Cs + Ci]Where :

P = PayoffHb = hours before implementation

Ha = hours after implementation

W = average wage rateCh = hardware costs

Cs = software costs

Ci = laobr costsBina Nusantara University 8

• The formula is a representation of a cost-benfit analysis that can be as simple as summing the total implementation costs from the general ledger and aggregting the total intangible benefits.

• Additional savings from the help desk can be added by accounting for quick troubleshooting, better customer service due to fewer downtime occurences, and improved customer satisfaction and retention.

• The cost-benefit approacth is a practical approach for most situations, however, the dept of the analysis depends upon the deman for IT justification and other factors contributing to IT payoff.


Break Evan Point (BEP) • Is generally used to identify the point at which

the system investment has paid for itself• BEP is the same as cost-benefit analysis, when

the cost=benefits or cost – benefits = 0• The payback period determines the duration of

time in which the system is paying for itself. The duration of time during which the BEP is reached.

• Whereas the BEP may be expressed in units of service or parts, the payback period is expressed in units of time such as the number of weeks, months, or years


Net Present Value (NPV)• Represent time value of money• Discount Factor (DF) is the rate at which the

company would have accumulated more money if it had not invested in the IT.

• This is based upon the interest rates and the returns from the stock market. Calculating DF is usually the more challenging part because it requires experience and educated guesswork as to how the market will behave in the future.


• How can NPV help in measuring IT payoff?– The investment in IT payoff competes with other

investments such as manufacturing equipment, additional distribution centers, and advertising. Managers may examine the NPV value of continued investment in IT agains that of other investments in determining the expected payoff and then decide which investment to make.


The Real Options Approach


(a) Expected NPV Payoff

(b) Pushing NPV using Real Options

Year 2

Year 3

Year 4

(c) Expected Payoff with Real Options

The Real Options Approach(a) Indicates the NPV concept, shere the shaded area

is the most likely NPV. The right side area is the most likely NPV. The curve represents the likelihood of the value over the 4-year period of the investment. the curve assumes that once the decision to invest is made, it will continue to occur at the same pace for the next 4 years. The right side area represents the likelihood of the expected payoff.


(b) at each year starting the second year, the management can evaluate the IT investment payoff and set the future direction, in effect pushing the curve so that the opportunities are availed f and the risks mitigated

(c) Indicates the revised the right area using the Real Options approach. As is evident, pushing the curve out leads to an increased likelihood of achieving the expected payoff.


• The key contribution of the Real Options approach is its ability to take advantage of unexpected or or unforeseen opportunities.

• The real options approach would then be comparable to a 30 year lease where one has the option to renew the terms, sublease the property, and the lease in each year, or buy the property.


Economic Value Added (EVA)• Is defined as the return on invested capital, that

is, after-tax cash flow generated by a company, minus the cost of the capital in creating the cash flow.

• For IT payoff, EVA can serve as a complementary tool, when NPV and Real Options are being calculated by accounting for the cost of capital to assess the value of the investment.


Statistical Approaches• To assist in finding and understanding the

relationship between the investment and payoff. – Examine the correlation table listing the strength of the

relationship between the investment (independent) variables, and the payoff (dependent) variables.

– A perfect positive correlation is indicated by a coefficient of 1.0 and no correlation is indicated by a coefficient of 0.

• Since the correlation of 1.0 is a perfect relationship, this indicates a strong relationship between IT investment and payoff.


• The regression equation will convey the extent to which the variation in profit can be explained by workload, number of orders, and expenditures on IT through the reported statistic R-square.

• The significance of F value will suggest if our proposed relationship is statistically valid.

• The coefficient and their corresponding p values will show the extent to which each independent variable contributes to determining profits and the confidence we can plance in determination.


Documents

TECHNOLOGY JUSTIFICATION MODELS Pertemuan 15-16 Matakuliah: A0814/Investment Analysis Tahun: 2009