Cost Benefit Analysis

1. Discuss in detail why an organization must analyze the need for applications and justify it in terms of cost and benefits.

Cost-benefit analysis is a technique that can be used to compare the total costs of a

project with its benefits. The most commonly used metric for cost-benefit analysis is monetary units which enables the calculation of the net cost or benefit associated with the project. This technique is typically performed at the beginning of a project since various options or courses of action are being considered or evaluated during this time. In addition to using cost-benefit analysis to determine the best approach for a project, it can also be utilized to calculate the overall impact that the project will have financially. One of the reasons it is important to implement techniques such as cost-benefit analysis for new projects is because the success rate of IT projects is not 100%.

The question that needs to be answered when assessing the economic feasibility of the implementation of a new application is “does the project make financial sense?” Some of the potential costs when implementing a new application include hardware/software upgrades, the cost of labor, support costs for the application, training costs, and expected operational costs. Some of the potential benefits include increased revenue from the additional sales of the organizations products/services, reduced operating costs, and reduced personnel costs from a reduction in staff. These potential costs and benefits are considered quantitative, but there are also qualitative costs and benefits that should be considered. For example, potential costs that are qualitative include increased employee dissatisfaction due to the fear of change and negative public perception due to layoffs made as the result of automation. Qualitative benefits may include positive public perception that the organization is an innovator and improved decisions due to increased access to accurate and timely information.

1. Discuss in detail how economists measure productivity. Also discuss concepts behind labor productivity, the productivity paradox and explanations of the apparent productivity paradox.

Labor productivity can be defined as the amount of output per worker. The higher the

amount of output, the more workers contribute to profits for the company. When measuring productivity, economists must consider many factors. The simplest way of measuring productivity is to take the units of output and divide it by the units of input. In this scenario the units of output is the product and the units of input can be things such as capital, labor and materials. However, there are instances in which the quality factor must also be considered. For example, workers who produce high-quality products such as Swiss luxury watches may need more time to produce them. Additionally, it becomes more complex when attempting to measure the productivity of workers who do not produce something physical.

The productivity paradox attempts to explain the discrepancy between the investment in IT growth and the national level of productivity and productive output. This terminology became popularized after appearing in the title of a paper by Erik Brynjolfsson in 1993, a Professor of Management at the MIT Sloan School of Management. Brynjolfsson’s argument was that although there doesn’t appear to be a direct, measurable correlation between improvements in IT and improvements in output, this may actually be more of a reflection on how productive output is measured and tracked. Some possible causes of the productivity paradox include mismeasurement, redistribution, time lags, and mismanagement. According to Paul David, an economist at Oxford University, we will not see significant leaps in productivity until both the United States and major global powers have all obtained at least a 50% penetration rate for computer use.

2. Discuss in detail traditional financial methods used to evaluate investment decisions including present value (NPV), internal rate of return (IRR), and payback period including scenarios when one over the other would be more appropriate.

After IT projects have been identified, it is the responsibility of management to begin the financial process of figuring out whether or not the project is worth pursuing. When determining this, there are three common capital budgeting decision tools that are utilized. These tools are the payback period, net present value (NPV) method and the internal rate of return (IRR) method. The NPV tool is probably the most commonly used and is more effective when evaluating a project. It is a calculation that involves determining the difference between