Benefitcost Analysis BCA

Organizations often regard information systems expenditure as costly and risky, and these IT investments directly affect the budgets. Despite the importance and cost, many IT investments appear to go ahead without the use of normal investment appraisal and risk management techniques. One such technique used to justify IT projects is the benefit-cost analysis (BCA). The project manager and the project team perform the BCA, as one person rarely has all the expertise to complete a BCA.

Performed during the initiation phase, the BCA essentially weighs the benefits against the costs of a project and is normally measured in monetary terms. If monetary values cannot be assigned, then relative values for benefits and costs can be used. In simplified terms the benefit-cost analysis clearly shows the project manager the "dollar burn rate." The purpose of a BCA is to support better decision-making. Project managers can use this technique to calculate for every dollar invested on the project, the dollar amount expected to receive back.

For example, let's assume that the marketing department expects to achieve results of $50,000 on the product and the project manager has determined that it will cost the client $35,000 to implement the project. Forecasted figures show a 70 percent probability of this occurring, and estimated profits are projected at 20 percent. Table 4.6 reflects the scenario where a positive BCA is achieved.

BCA = Estimated Benefits * (Estimated Profit*)

Table 4.6: Calculating the benefit-cost analysis (when profit is computed in numerator)

Assumptions

Formula Application |

Estimated Benefits (Sales) = $50,000

BC - (£50,000 x 0.2 x 0.7)

Probability of Success = 70% or (0.7)

Estimated Profit = 20% (0.2)

= $7,000 $35,000

Estimated Costs = $35,000

BC = 0.2[a]

Note: If you remove the estimated profit percentage from the benefit cost ratio formula then you calculate your break even point. (B/C ratio = 1.0). For this to happen the formula must contain revenue not profit.

[a]Where > 1.0: Profitable, benefits exceed the cost. Where < 1.0: Unprofitable, costs are greater than the benefits. Where = 1.0: Benefits balance cost, neither win or lose.

This example shows a benefit-cost ratio of 0.2. This implies that for every dollar invested, the client can expect to receive 20 cents. Which is not a bad result (20% return on investment).

Remember that when a BCA has been performed and compared to an alternative BCA and they both come out with similar costs and different benefits, then the BCA providing the greatest benefits to the project should be selected. Accordingly, if both BCAs have similar benefits but different costs, then the BCA with the lowest cost should be selected.

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