535handout_4 - IS/PM 535 Handout#4 Information Technology...

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1 IS/PM 535 Handout #4 Information Technology Investment: Decision-Making Methodology; by Marc J. Schniederjans, Jamie L. Hamaker and Ashlyn M. Schniederjans , World Scientific Publishing Co © 2004. The printed copy is extracted from DePaul 24x7 books for instructional and printing purpose. Chapter 4: Basic Financial Methods Introduction Everyone who makes an investment in information technology (IT) will be expected to perform a convincing analysis to justify their proposed investment. In the previous chapters we have focused on many issues that will help begin the preliminary steps in that analysis. This chapter is the first of several chapters focusing on fundamental financial components or the "basic financial methods" expected in IT investment decision-making analysis. What are the Basic Financial Methods? Financial methodologies, in general, are rooted in subject areas of Finance and Accounting, and have been used in traditional "capital budgeting decisions" for many years. Capital budgeting decisions are those concerning investment in real assets, e.g., machinery, facilities, management expertise and information technology. Real assets tend to be long-lived assets, meaning they will be used for a long period of time, often several years. However, the useful life of an IT investment tends to be shorter than that of the typical real asset (e.g., a facility or piece of machinery is often used for several decades where as information system may become obsolete in two to three years). Capital budgeting techniques are commonly used in IT investment decision-making and it is assumed that an IT that produces benefits beyond one year is considered to be a long-lived asset. In other words, capital budgeting techniques may be employed because an IT investment produces benefits beyond one year and its useful life extends into the long-term future. Financial methodologies may be divided into two categories: (1) basic financial methods; and (2) advanced financial methods. Basic financial methods are those most often employed because of their simplicity and include breakeven analysis, payback period methodology and accounting rate of return methodology. Basic financial methods are easy to calculate, understand and communicate to others. Their simplicity appears to be their attraction. There are other methods, considered advanced financial methods . Some of these are presented in Chapter 5 of this textbook and include present value analysis, profitability index, return on investment and internal rate of return methodologies. The calculation for these techniques is more involved and, for several of these methodologies, requires knowledge and understanding of the time value of money and present value. Present value analysis involves discounting cash flows received in the future to their present value so the computation is more difficult than that of the more basic financial methods.
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