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 –benefit
analysis (CBA) is important.

BENEFITS > COSTS

 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.

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 Cost Benefit Analysis
Decision making is about choices

 For an individual
 They 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 company
 Being 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 Government
 Decision 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.
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 Cost – Benefit Analysis
Other issues
 Is the project worthwhile financially?
 Is it the best option?
 Should it be undertaken at all?

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 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.

Identification of Evaluation of Choice of System

costs & benefits costs & benefits

1 . Identification of Costs & Benefits :

Identify the costs & benefits associated with a task/operation, or
investment project.
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
 Cost – Benefit Analysis
Establishing a steel production plant in a port
community
Costs (-)
 construction.
 pollution.
 devaluing house prices etc.
Benefits (+)
 employment
 Increased port trade
 steel for local industry

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 Cost - Benefit Analysis
Method
 Identify 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 ]

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 Cost - Benefit Analysis
CBA unlikely to be a useful
technique 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.

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CBA via Portfolio Analysis for Information System
Project Risk
High Low
High

B Cautiously Examine Identify & Develop

E
N
E
F
I
T Avoid Routine Projects
S

Low
CBA via Profitability Index for Information System

Profitability Index = PV of Cash inflows

Investment

CBA via Dividend Payback Period

Payback Period = Total Initial Investment

Discounted Annual Cash
inflow
CBA via Accounting Rate of Return for Information
System

Accounting Rate of Return = Average Net Return

Total Initial Investment
 Problems Associated with CBA
Measurement Problems
 Difficulties 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.

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 Time Problems
 Tackling 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.

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