Assumed Monetary Benefits Of An Information System Of 40,000
Assume Monetary Benefits Of An Information System Of 40000 The First
Assume monetary benefits of an information system of $40,000 the first year and increasing benefits of $10,000 a year for the next five years (year 1 = $50,000, year 2 = $60,000, year 3 = $70,000, year 4 = $80,000, year 5 = $90,000). One-time development costs were $80,000 and recurring costs were $45,000 over the duration of the system's life. The discount rate for the company was 11 percent. Using a six-year time horizon, calculate the net present value of these costs and benefits. Also, calculate the overall return on investment and then present a break-even analysis. At what point does break-even occur?
Paper For Above instruction
The evaluation of information systems investment relies heavily on financial analysis techniques such as Net Present Value (NPV), Return on Investment (ROI), and break-even analysis. These tools help organizations assess whether the benefits derived from the system justify the costs over its operational lifespan. This paper demonstrates the application of these methods using a hypothetical scenario where an organization considers an information system with specified costs and benefits over six years, with an 11% discount rate.
Scenario Overview:
The system under consideration yields monetary benefits beginning at $40,000 in the first year, with benefits increasing by $10,000 annually, resulting in yearly benefits of $50,000, $60,000, $70,000, $80,000, and $90,000 over five years. The initial development cost is $80,000, and recurring costs amount to $45,000 throughout the system's lifespan. The analysis spans six years, incorporating a discount rate of 11%, which accounts for the time value of money and risk factors.
Calculating Net Present Value (NPV)
The NPV is a core financial analysis metric that aggregates the present value of all benefits and costs, discounting future cash flows to their current value. The formula involves discounting each year's net cash flow (benefits minus costs) at the given discount rate.
The benefits over six years are as follows:
- Year 1: $50,000
- Year 2: $60,000
- Year 3: $70,000
- Year 4: $80,000
- Year 5: $90,000
- Year 6: $90,000 (assuming benefits stabilize or similar to Year 5)
Recurring costs per year are $45,000, and the initial development cost is a one-time expense of $80,000 occurring at Year 0.
To compute NPV, each year's net cash flow is calculated as: Benefits - Recurring costs. The initial investment cost is included as a negative cash flow at Year 0.
Using the formula for present value (PV) of future cash flows:
PV = Future Cash Flow / (1 + r)^t
where r is the discount rate (11% or 0.11), and t is the year number.
Calculations
- Year 0: Initial costs = -$80,000
- Year 1: ($50,000 - $45,000) / (1 + 0.11)^1 ≈ $4,504.50
- Year 2: ($60,000 - $45,000) / (1 + 0.11)^2 ≈ $13,234.37
- Year 3: ($70,000 - $45,000) / (1 + 0.11)^3 ≈ $19,559.15
- Year 4: ($80,000 - $45,000) / (1 + 0.11)^4 ≈ $23,357.91
- Year 5: ($90,000 - $45,000) / (1 + 0.11)^5 ≈ $25,498.62
- Year 6: Assuming benefits remain at $90,000: ($90,000 - $45,000) / (1 + 0.11)^6 ≈ $22,939.58
Adding all present values:
NPV = -$80,000 + Σ (Year t benefits - costs discounted)
NPV ≈ -$80,000 + $4,504.50 + $13,234.37 + $19,559.15 + $23,357.91 + $25,498.62 + $22,939.58 ≈ $28,094.13
Return on Investment (ROI)
ROI measures the profitability of the investment and is calculated as:
ROI = (Total Benefits - Total Costs) / Total Costs
Total benefits over six years sum to $50,000 + $60,000 + $70,000 + $80,000 + $90,000 + $90,000 = $440,000.
Total costs include the initial development cost + total recurring costs:
Initial development: $80,000
Recurring costs: $45,000 * 6 = $270,000
Total costs: $350,000
ROI = ($440,000 - $350,000) / $350,000 ≈ 0.257 or 25.7%
Break-even Analysis
Break-even occurs when the accumulated discounted benefits equal the total costs. To find this point, cumulative discounted cash flows are calculated year-by-year to identify when benefits surpass costs.
Annual net benefits (discounted) are as previously calculated. Summing the discounted benefits annually yields cumulative benefits:
- End of Year 1: $4,504.50
- End of Year 2: $17,738.87
- End of Year 3: $37,298.02
- End of Year 4: $60,655.93
- End of Year 5: $86,154.55
- End of Year 6: $109,094.13
Since total costs are $350,000, the cumulative benefits do not reach this amount within six years. Therefore, the system does not fully break even within this horizon. To approximate the break-even point, one would extend the analysis beyond six years or consider reinvestment of benefits, but within the six-year scope, the system is profitable based on NPV.
Conclusion
Applying financial analysis techniques reveals that the information system in question has a positive net present value of approximately $28,094.13 over six years at an 11% discount rate. The ROI stands at approximately 25.7%, indicating a favorable investment. The break-even point, in terms of discounted benefits matching initial costs, exceeds the six-year horizon, implying the system starts generating positive returns before the sixth year but does not fully recoup initial investments within this period. These insights assist decision-makers in evaluating the financial viability of implementing the system and planning for long-term gains.
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