Explanation of Cost-benefit analysis with example | Fourth Semester | BSc.CSIT (TU)

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cost-benefit-analysisDescription of Cost-benefit analysis with example | BSc.CSIT
Fourth Semester | Second Year | Tribhuvan University (TU)
Subject: System Analysis and Design (SAD)

Cost Benefit Analysis
Cost benefit analysis is the process of identifying the financial benefits and costs associated with development project. It is important to spend adequate time identifying and quantifying the benefits and costs related to a particular project or it would be impossible between rival projects.

Tangible benefits:

  • Cost reduction and avoidance
  • Error reduction
  • Increased flexibility
  • Increased speed of activity
  • Improvement of management planning and control
  • Opening new markets and increasing sales opportunity

Intangible benefits:

  • Can’t be measured easily in dollars
  • May have direct organizational benefits such as improvement of employee morale and they have broader social implication such as reduction of waste creation
  • Competitive necessity
  • More timely information
  • Improved organizational planning
  • Improved organizational flexibility
  • Availability of new, better and more information.

Determining project cost

Tangible costs

  • Tangible costs could be considered as items that we can easily measure in dollars with certainty.
  • For example; Hardware cost, labour costs, operational costs, employee training cost, building renovations.

Intangible cost

  • Loss of customer goodwill, employee morale, operational inefficiency.

We should consider several guidelines for improving cost estimation. Under estimating and over estimating cost should be avoided. Under estimating results in cost overruns and over estimating cost result unnecessary allocation of resources that might be better utilized.

One time costs

  • Associated with project initiation and development and the startup of system
  • System development, new hardware software purchase, user train

Recurring cost

  • Cost resulting from ongoing evolution and use of system
  • Application software maintenance
  • Incremental data storage expenses
  • Incremental communications
  • New software and hardware leases
  • Supplies and other expenses

Time value of money
It is a concept that money available today is worth more than the same amount tomorrow. All cost and benefit must be viewed in relation to their present value when comparing investment options.
PVn = y + 1/(1+i)n
where PVn = present value of Y dollars ‘n’ years from now when ‘i’ is the discount rate

Create summary worksheet reflecting present values of all benefits and costs as well as all pertinent analysis. All cost benefit analysis calculations will be made using five year time horizon as upper boundary

Overall Return on investment (ROI)
Overall Return on investment (ROI) is useful in making project comparison on economic basis. Break even analysis is to discover at what point benefit equals cost.
Break even ratio = (Yearly NPV cash flow – Overall NPV cash flow)/ Yearly NPV cash flow
Where, NPV=net present value

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