IS/PM 535 Handout #6
Information Technology Investment: Decision-Making Methodology by Marc J. Schniederjans,
Jamie L. Hamaker and Ashlyn M. Schniederjans World Scientific Publishing Co
DePaul 24x7 books, Extracted text for instructional and printing purpose.
Chapter 6: Cost/Benefit Analysis
In this chapter we introduce a classic financial IT methodology called "cost/benefit analysis." It is a
methodology that seeks to overcome some of the limitations of the return on investment (ROI)
methodology discussed in Chapter 5
. It does this in part by considering the usual cost information
found in ROI analysis, but combined with "benefits" (not considered in ROI). As such it considers the
all important and often intangible "value-added" contributions of personnel and managers. By bringing
into the analysis more relevant criteria, cost/benefit analysis has become one of the most commonly
used and appreciated financial methodologies in IT investment decision-making.
What is Cost/Benefit Analysis?
involves the estimation and evaluation of the net benefits associated with
alternative courses of action. This technique most often entails comparing the present value of benefits
associated with an investment to the present value of the costs of the same investment. Cost/benefit
analysis is a widely used decision-making tool in both public and private settings and for a wide
variety of different problems, including IT investment decision-making (Brown, 2001; Farbey,
, 1993; Ryan, 2002; Sassone, 1988).
Cost/benefit analysis involves identifying costs and benefits for each alternative investment,
discounting the costs and benefits back to the present, and selecting the best alternative according to a
pre-specified criterion. Cost/benefit analysis may be used to evaluate an independent investment and
to select one or several among a set of independent or dependent investments. Cost/benefit analysis
may be used for
(i.e., before project analysis),
(i.e., after project analysis) and in
(i.e., in progress analysis) investment evaluations. Like most analyses, cost/benefit analysis
involves a series of steps or stages. Figure 1
shows five common stages in conducting a cost/benefit
analysis. These sequential stages include: defining the problem, identifying costs and benefits,
choosing a criterion, comparing alternatives, and performing sensitivity analysis. Each phase is
discussed in more detail in the following sections.