Business IT
IS535 / PM535
Tuesday 5:45 – 9:00
IT Investment Financial Analysis
Agenda 05/07/10: Class #6
WSJ
Profitability Index
ROI
Cost Benefit Analysis
WSJ
3
Privacy or increasing advertising revenue ?
Google is set to launch new tools to limit the use of tracking cookies, a move that could strengthen the search giant’s advertising dominance and deal a blow to other digital-marketing companies
After years of internal debate, Google could as soon as this week roll out a dashboard-like function in its Chrome browser that will give internet users more information about what cookies are tracking them and offer options to fend them off
Expected to be touted as part of the company’s commitment to privacy—a complicated sell, given the large amount of data it continues to store on users—while it presses its sizable advantage over online-advertising rivals.
The unit of Alphabet Inc. GOOGL 0.33% is the world’s largest digital ad seller. The coming changes aren’t expected to curtail significantly Google’s ability to collect data.
A cookie is a small text file stored in an internet browser that lets companies silently follow users around the internet, gathering information such as which sites they have visited and what ads they have viewed or clicked.
cookies also boost competition in the advertising landscape by allowing hundreds of digital firms—large and small—to collect their own user data and sell higher-priced ads based on it. Any restriction on them is a boon to the biggest tech companies, including Google, which can target ads based on the large amount of other information they collect on users through their many products.
Google, like its rivals in the browser business, isn’t planning to end the use of cookies that websites use to make their own users’ experience smoother, such as those that store login information so users don’t have to enter it every time. Instead, it is mostly targeting cookies installed by profit-seeking third parties, separate from the owner of the website a user is actively visiting.
Shares in one such company, Paris-based Criteo SA, which helps sites tag cookies on their visitors, are down 27% since Adweek reported in late March that Google was considering new restrictions.
WSJ
4
Kraft Heinz to Restate Financial Results Following Investigation
Kraft Heinz Co. KHC 0.58% said errors in its accounting go back several more years than previously known, widening the scope of the internal problems the beleaguered food company has to resolve while facing a federal securities probe and shareholder lawsuits. The company said Monday it is restating a host of its financial results dating as far back as 2016, after it determined they included certain misstatements. The adjustments now total $208 million. It has missed a handful of financial reporting deadlines, and Kraft Heinz couldn’t say Monday when the reports, including the full-year financial report for 2018, would be filed.
Investors have been seeking updates from Kraft Heinz in the three months since it disclosed the regulatory investigation and said it was writing down the value of some of its brands by $15 billion. Lead investor Warren Buffett has since said that Berkshire Hathaway Inc. BRK.B -2.49%and 3G Capital overpaid when they helped form Kraft Heinz through a merger in 2015. Mr. Buffett defended the company during his annual meeting over the weekend, but reiterated that deals can sour by paying too much.
The company is restating several financial statements beginning in 2016 and 2017. Its net income for 2016, 2017 and 2018 will change by less than a percentage point, the company has found so far. “The company is taking action to improve our policies and procedures and will continue to strengthen our internal financial controls,” the company spokesman said.
3G helped broker the merger of Kraft and Heinz, and worked to deliver profit by slashing the combined company’s workforce, curbing expenses and pushing suppliers to give more favorable terms. It also cut research and marketing spending at a time when many of Kraft Heinz’s signature packaged-food brands were losing favor with customers. Sales dropped as a result.
WSJ
5
Tech Giants Rethink the Businesses That Made Them Big
Facebook, Apple, Amazon and Google are seeking out new places to disrupt, but analysts say future ventures will likely be costly
Google, Facebook Inc. FB -0.81% and other tech giants have long tinkered with ways to grow outside the core businesses they dominate. Now those efforts are becoming urgent.
Apple Inc., AAPL -1.54% meanwhile, said last week its sales-and-profit slump extended into a second straight quarter—the first time that has happened in more than two years—thanks to falling sales of the iPhone, the product that turned it into a colossus. Its response has been to try to morph itself into a services company fueled by app and entertainment sales as much as hardware.
Google parent Alphabet Inc. GOOGL 0.33% has been Big Tech’s most eclectic big-idea factory. It has worked on self-driving cars for a decade and has arms devoted to everything from balloon-tethered internet access to extending human life. But it has had little success turning those efforts into moneymaking businesses. Advertising is still 85% of its revenue, and operating losses at its “other bets” segment ballooned by 52% in the last quarter to $868 million, Alphabet said last week
Amazon.com Inc. AMZN -0.61% won a vote of confidence last week from Warren Buffett’sBerkshire Hathaway Inc., which recently took a stake in the e-commerce giant. Jeff Bezos’ well-documented allergy to complacency has made Amazon a Big Tech forerunner in diversification. It launched a cloud-computing business 13 years ago that delivered almost 60% of its operating profit last year, and has built big operations in entertainment and groceries.
Still, as they stretch into new domains, tech’s titans increasingly bang into each other. Amazon’s advertising effort is impinging on Google and Facebook, both of which are also muscling up against Amazon in e-commerce. Facebook’s messaging shift threatens Apple, whose Messages app is important to its services push. So do Amazon and Google’s forays into hardware. Apple’s Hollywood campaign encroaches on Amazon, which already spends billions of dollars annually producing entertainment.
WSJ
6
Uber Wants to Be the Uber of Everything—But Can It Make a Profit?
In Uber’s vision of the future, most people won’t own cars. Riders will hop on electric bikes and scooters for short distances, and summon cars with drivers for longer rides. Takeout dinner will become a vestige, replaced by hand-delivered meals. Garages will empty and parking lots will be ripped up and transformed into grassy parks.
Eventually, robots will rule. Self-driving cars will shuttle people around the roads—and in the air—while drones will make the deliveries. Robotrucks will roam the highways. And Uber will be at the center of it all.
But first, there’s the question of whether Uber will ever make any money
As Uber gets set to go public next Friday in one of the largest tech IPOs ever, Chief Executive Dara Khosrowshahi is trying to sell Wall Street on his vision that Uber will become the dominant force in all forms of transportation.
That mission is threatened by an onslaught of competition from all sides that has intensified in recent months and caused Uber’s loss to balloon to more than $3.7 billion in the 12 months through March—by far the largest loss ever for a U.S. startup in the year before an IPO, according to S&P Global Market Intelligence.
And Uber’s version of the future is still far from a certainty. Uber’s main markets are in dense cities, but according to some estimates more than 70% of the U.S. population lives in rural or suburban areas—where car ownership tends to be more convenient and cheaper. Ride-hailing has disrupted the taxi-cab industry, but it has also lured people from public transit and helped clog major cities, spurring calls for more regulation that would limit growth
“If they want a predictably profitable company--go buy a bank,” he added with a shrug. “Really the long-term is what we’re after.”
The Amazon of transportation
WSJ
7
CFOs Overhaul Performance Measures in Response to New Accounting Rules
As companies recategorize lease expenses, common earnings metrics are getting skewed, prompting companies to shift to new benchmarks
New international lease accounting rules are prompting some finance chiefs to overhaul how they benchmark corporate performance—a challenging move that could disenfranchise investors married to metrics once used to compare performance to past results. Companies in more than 140 countries that require the application of International Financial Reporting Standards have to transition this year to new lease accounting rules. Finance chiefs must now report leases on the balance sheet as assets and liabilities—a break from prior rules that allowed some leases to be recorded in footnotes to financial statements.
The changes will cause many companies to report higher earnings before interest, taxes, depreciation and amortization, as well as higher free cash flow, a measure of cash earned from operations after capital spending. Meanwhile, some credit metrics, such as leverage ratios and earnings per share measures, will appear weaker in certain instances.
Before the rule change, investors and analysts didn’t have a complete picture of the financial position of a company because of the absence of certain leases on the balance sheet, according to the International Accounting Standards Board, which set the new lease standard.
This is set to interrupt the consistency Wall Street analysts and investors prefer in company reports. Finance chiefs say they’re making the new figures easily comparable with metrics used under the old accounting rules.
Under the new standard, lease payments are split into two components, only one of which is considered when calculating free cash flow, resulting in a higher figure.
“Every company that adopts the new standard will get a boost in reported free cash flows arising from the recategorization of operating lease payments,” said Trevor Pijper, a vice president at Moody’s Investors Service Inc. “Investors could then ask, ‘What are you doing with all this free cash?’”
Profitability Index (PI)
Pi index is a ratio that can be used to rank projects when the size of the initial investments varies for the alternative investments in a mutually exclusive sets. PI is the ratio of NPV to the cost of the initial investment
PI = Present Value of Future Cash Flows / Initial Investment
OR
PI = (Net Present Value + Initial Investment) / Initial Investment
Profitability Index (PI)
The Profitability Index (PI) measures the ratio between the present value of future cash flows and the initial investment. The index is a useful tool for ranking investment projects and showing the value created per unit of investment.
PI = Present Value of Future Cash Flows / Initial Investment
OR
PI = (Net Present Value + Initial Investment) / Initial Investment
Profitability Index (PI)
If the PI is greater than 1, the project generates value and the company should proceed with the project.
If the PI is less than 1, the project destroys value and the company should not proceed with the project.
If the PI is equal to 1, the project breaks even and the company is indifferent between proceeding and not proceeding with the project
If the profitability index of a project is 1.2, for example, you can expect a return of $.20 for every $1.00 you invest in the project.
The higher the profitability index, the more attractive the investment.
Profitability Index (PI) – Calculate
You are charged with evaluating 3 alternative payroll systems
NPV & PI must be calculated for each investment alternative
PI = Present Value of Future Cash Flows / Initial Investment
OR
PI = (Net Present Value + Initial Investment) / Initial Investment
Profitability Index (PI) – Calculate
| C | $ 40,000 | |||||||||||
| r | 10% | |||||||||||
| Periods | 4 | |||||||||||
| Initial Investment | $ (100,000) | $ 40,000 | + | $ 40,000 | + | $ 40,000 | + | $ 40,000 | ||||
| 1.1 | 1.21 | 1.331 | 1.4641 | |||||||||
| PV | $ 126,794.62 | |||||||||||
| $ 36,363.64 | + | $ 33,057.85 | + | $ 30,052.59 | + | $ 27,320.54 | NPV | $ 26,794.62 | ||||
| PI | 1.267946179 | |||||||||||
| C | $ 5,000 | |||||||||||
| r | 10% | |||||||||||
| Periods | 4 | |||||||||||
| Initial Investment | $ (10,000) | $ 5,000 | + | $ 5,000 | + | $ 5,000 | + | $ 5,000 | ||||
| 1.1 | 1.21 | 1.331 | 1.4641 | |||||||||
| PV | $ 15,849.33 | |||||||||||
| $ 4,545.45 | + | $ 4,132.23 | + | $ 3,756.57 | + | $ 3,415.07 | NPV | $ 5,849.33 | ||||
| PI | 1.584932723 | |||||||||||
| C | $ 70,000 | |||||||||||
| r | 10% | |||||||||||
| Periods | 10 | |||||||||||
| Initial Investment | $ (150,000) | $ 70,000 | + | $ 70,000 | + | $ 70,000 | + | $ 5,000 | ||||
| 1.1 | 1.21 | 1.331 | 1.4641 | |||||||||
| PV | $ 177,494.71 | |||||||||||
| $ 63,636.36 | + | $ 57,851.24 | + | $ 52,592.04 | + | $ 3,415.07 | NPV | $ 27,494.71 | ||||
| PI | 1.183298044 |
Profitability Index (PI)
System B is the best alternative
System A & C only get .27 and -.18 per dollar spent while System B returns .58 per dollar
Profitability Index (PI)
Assuming the organization has unlimited funds then payroll C adds the most value, and is best alternative.
When funds are limited, being under capital rationing constraints, then payroll B provides the largest contribution per dollar spent. (Biggest bang for your buck)
The net present value (NPV) method should be preferred, except under capital rationing, because the NPV reflects the net increase in the firm’s wealth.
Profitability Index (PI) – Calculate
Build the problem at the board and validate in excel
| Project A requires an initial investment of $1,500,000 to yield estimated annual cash flows of: | ||||||
| 10% | Discount Rate | |||||
| 1,500,000 | initial investment | |||||
| $150,000 in Year 1 | ||||||
| $300,000 in Year 2 | ||||||
| $500,000 in Year 3 | ||||||
| $200,000 in Year 4 | ||||||
| $600,000 in Year 5 | ||||||
| $500,000 in Year 6 | ||||||
| $100,000 in Year 7 |
| Project B requires an initial investment of $3,000,000 to yield estimated annual cash flows of: | ||||||||
| 13% | Discount Rate | |||||||
| 3,000,000 | initial investment | |||||||
| $100,000 in Year 1 | ||||||||
| $500,000 in Year 2 | ||||||||
| $1,000,000 in Year 3 | ||||||||
| $1,500,000 in Year 4 | ||||||||
| $200,000 in Year 5 | ||||||||
| $500,000 in Year 6 | ||||||||
| $1,000,000 in Year 7 |
Summary
Both measures consider an investment future cash flow. However, net present value gives you the dollar difference, while the profitability index gives the ratio.
Net Present Value is considered as one of the most desirable types of evaluation, analysis, and selection of great investments. However, we should note that we have to be very careful when estimating cash flows, since an incorrect cash flow estimation may lead to deceptive NPV.
The net present value (NPV) and profitability (PI) yield same accept or reject rules, because profitability index (PI) can be grater than one only when the project’s net present value is positive.
Return on investment Methodology
ROI methodology is another technique traditionally used in capital budgeting decisions where rate of return on investments are compared to the opportunity cost of capital
Return on investment Methodology
The return on investment is calculated as the profit of the investment divided by the cost of investment
If the return from the investment is greater than the opportunity cost of capital then the investment is worth more than it costs and should be undertaken
Return = Profit / Investment cost
Return on investment Methodology
The opportunity cost of capital may be thought of as the expected return forgone by investing in the technology rather than in an equally risky investment in the capital market
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $100,000
Return: $115,000 (end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ?
ROI = Profit / Investment cost
OR
ROI = Return – Cost / Investment
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $100,000
Return: $115,000 (end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ?
Return = $115,000 - $100,000 / $100,000 = 15%
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
The return is 15% which is > 12% which is the opportunity cost of capital
Return = $115,000 - $100,000 / $100,000 = 15%
Return = Profit / Investment cost
Return on investment Methodology
Rules of ROI Methodology:
If return is > the opportunity cost of capital, then make the investment
If return is < or equal to the opportunity of capita, then do not make the investment
Return = $115,000 - $100,000 / $100,000 = 15%
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $300,000
Return: $330,000(end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ?
Should we move forward?
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $300,000
Return: $330,000(end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ? 10%
Should we move forward? No < 12%
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $10,000
Return: $12,000(end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ?
Should we move forward?
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $10,000
Return: $12,000(end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ? 20%
Should we move forward? Yes > 12%
Return = Profit / Investment cost
Return on investment Methodology
Lets evaluate a technology investment:
Costs: $500,000
Return: $560,000 (end of 1 year)
Similar risk as an investment in the capital market @ 12%
What is the return ?
Should we move forward?
Return = Profit / Investment cost
Return on investment Methodology
You buy 1,000 shares of Jim Shoes Jim Shorts company for $10.00.
One year later you sold the share for 12.50 and you earned $500 in dividends.
The transactions cost $125 on trading commissions
What is your ROI?
Work this on the board -
Return on investment Methodology
You buy 1,000 shares of Jim Shoes Jim Shorts company for $10.00.
One year later you sold the share for 12.50 and you earned $500 in dividends.
The transactions cost $125 on trading commissions
What is your ROI?
| ROI | |||||
| Cost | 10,000 | 1000 shares * 10 | |||
| Return | 12,875 | (1000 * 12.50) + 500 - 125 | |||
| Similar Risk | 12% | ||||
| ROI | 12875 | Minus | 10000 | divided by | 10000 |
| ROI | 28.75% |
Return on investment Methodology
Issues ROI Methodology:
Only really works if cash flows are in 2 periods
When there are more than 2 periods it is questionable whether this method yields the true return
Researchers suggest if you go beyond 2 periods use Internal rate of return (IRR)
ROI should be used as a supplement to other methodologies
Return on investment Methodology
Issues ROI Methodology:
Only really works if cash flows are in 2 periods
When there are more than 2 periods it is questionable whether this method yields the true return
Researchers suggest if you go beyond 2 periods use Internal rate of return (IRR)
ROI should be used as a supplement to other methodologies
Cost Benefit Analysis
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 setting for a wide variety of different problems, including IT investment decisions.
Cost Benefit Analysis
Constantly facing resource and allocation decisions
Purchase new software
Hire new employees
You use a cost-benefit approach when making these decisions
You should spend the resources if the expected benefit to the company is exceeds the expected costs
Cost Benefit Analysis: For Example
Installing the company first budgeting system
Benefits:
Ability to compare past budgets to current
Ability to take historical data and make corrective actions
Better decision making
Better company performance
** Exact benefits are hard to define
Cost Side
Software
Training
Hardware / Support costs
Compare benefits and expected costs, exercise judgement, and reach a decision
Cost Benefit Analysis
Cost/ Benefit analysis involves identifying costs and benefits for each alternative investment, discounting the costs and n=benefits back to the present, and selecting the best alternative according to a pre-specified criterion.
Cost Benefit analysis involves a series of stages or steps
Cost Benefit Analysis:
5 common steps
Defining the Problem
Identifying costs and benefits
Setting the criteria
Comparing alternatives
Performing sensitivity analysis
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Defining the Problem
In Depth Analysis of the situation
Investigating the needs and requirements
Define the problem in detail
Specification of the objective
Plan to attain those objective
Examples:
Improved customer service
Enhanced inventory control
A well defined plan includes a plan to attain the objectives
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Defining the Problem
Identifying all possible alternative courses of action and then if necessary narrowing this list down by eliminating unacceptable alternatives.
Eliminating the ones that do not meet budgetary, legal or social constraints
Expensive method because it is very comprehensive
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Defining the Problem
What are some of the problem IT project are trying to solve?
Give some examples
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
Identify the relevant costs and benefits
Identifying relevant effects and assigning a value is one of the most challenging stages
They may be positive or negative
Overlooking any costs or benefit my unfavorably affect the final selection
Over estimating or under estimating can adversely affect the result
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
Cost: any expenditure that must be incurred to procure, install and maintain
Cost: Tangible and directly attributed to the system
Cost: Intangible, cannot be readily assigned a value of the common unit of measure (Usually Dollars) and not directly attributed to the investment.
Tangible and Intangible should be evaluated in an IT investment decision
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
What are some examples of tangible costs?
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
Hardware
Software
Telecommunications
Services (Installation, development)
Personnel
Maintenance costs
Data Center costs
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
What are some examples of intangible costs?
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
Resistance to change (Change Management)
Inability to change
Organizational Restructuring
Integration of new system into current environment
Learning curve and loss of productivity
Policies and controls
Disruption to normal work practices
Downtime to install new system
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the cost benefit
Intangible costs can impact the overall success or failure of a project
Example of time sheets
Resistant to change
They can have a major impact
Example: Print out invoices in Mexico City SAP implementation
Inability to change due to customer requirement not taken into account
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of benefit
Benefits generally fall in to one of the following categories:
Cost savings / Avoidance
Error reduction
Improved operational performance
Increased flexibility
Improved planning and controls
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the benefit
Provide some examples of tangible Benefits
Increased Productivity
….
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Identification and quantification of the benefit
Provide some examples of tangible Benefits
Increased Productivity
Decreased operational costs
Reduced work force
Lower in house development costs (New technology / skill sets)
Cost Benefit Analysis
Cost/ Benefit analysis 5 common steps:
Compare Alternatives
Example:
PV of the Costs
PV of the Benefits
Create Criteral
Maximize the ratio of benefits over cost
Maximize the NPV value of the net benefits
Cost Benefit Analysis
Using the following data calculate the PV Cost and PV Benefits, Benefit Cost Ratio , NPV of benefits
Cost Benefit Analysis
PV Cost = Cost (Year) / (1+discount rate)^ Year +……
PV Benefit = Savings (Year) / (1+discount rate)^ Year +……
Cost Benefit Analysis
If a project has a BCR that is greater than 1, the project will deliver a positive NPV and will have an internal rate of return (IRR) above the discount rate. This suggests that the NPV of the project’s cash flows outweighs the NPV of the costs, and the project should be considered.
If the BCR is equal to 1, the ratio indicates that the NPV of expected profits equal the costs.
If a project's BCR is less than 1, the project's costs outweigh the benefits and it should not be considered.
Cost Benefit Analysis
Calculate the NPV of Net Benefits
Cost Benefit Analysis
Let do an example together Calculate using 10% as return (PV Cost, PV Benefits, BCR, NPV Benefits)
| System A | |||||
| Costs | 1 | 2 | 3 | 4 | |
| Hardware | 25,000.00 | 2,500.00 | 2,500.00 | 2,500.00 | |
| Software | 15,000.00 | 1,500.00 | 2,000.00 | 2,500.00 | |
| Services | 50,000.00 | 20,000.00 | 20,000.00 | 20,000.00 | |
| Total | 90,000.00 | 24,000.00 | 24,500.00 | 25,000.00 | |
| Benefits | |||||
| Increased productivity | 55,000.00 | 55,000.00 | 40,000.00 | ||
| Lower Error rates | 12,000.00 | 12,000.00 | 12,000.00 | ||
| Total | 67,000.00 | 67,000.00 | 52,000.00 |
Cost Benefit Analysis
Sensitivity analysis benefits NPV as well as cost benefit analysis in that it determines the degree of error in the estimates, especially for intangible costs and benefits. By selecting high and low values of a parameter, the effects on the NPV (or cost benefit analysis) can be assessed. If you vary one parameter, it may show you that a different alternative should be selected. Again, this helps in the ‘what-if analysis’ of the different alternatives.
System A System B System C Initial Cost 100,000$ 10,000$ 150,000$ CF Year 1 40,000$ 5,000$ 70,000$ CF Year 2 40,000$ 5,000$ 70,000$ CF Year 3 40,000$ 5,000$ 70,000$ CF Year 4 40,000$ 5,000$ 5,000$ r 10% 10% 10%
Calculate PV, NPV, PI 3 Investment alternatives
System ASystem BSystem C
Initial Cost 100,000$ 10,000$ 150,000$
CF Year 1 40,000$ 5,000$ 70,000$
CF Year 2 40,000$ 5,000$ 70,000$
CF Year 3 40,000$ 5,000$ 70,000$
CF Year 4 40,000$ 5,000$ 5,000$
r 10%10%10%
Calculate PV, NPV, PI
3 Investment alternatives
System A System B System C Initial Cost 100,000$ 10,000$ 150,000$ CF Year 1 40,000$ 5,000$ 70,000$ CF Year 2 40,000$ 5,000$ 70,000$ CF Year 3 40,000$ 5,000$ 70,000$ CF Year 4 40,000$ 5,000$ 5,000$ r 10% 10% 10%
Calculate PV, NPV, PI 3 Investment alternatives
System ASystem BSystem C
Initial Cost 100,000$ 10,000$ 150,000$
CF Year 1 40,000$ 5,000$ 70,000$
CF Year 2 40,000$ 5,000$ 70,000$
CF Year 3 40,000$ 5,000$ 70,000$
CF Year 4 40,000$ 5,000$ 5,000$
r 10%10%10%
Calculate PV, NPV, PI
3 Investment alternatives
Profitability Index (PI)
System B is the best alternative System A & C only get .27 and - .18 per dollar spent while System B returns .58 per dollar
System A System B System C Initial Cost 100,000$ 10,000$ 150,000$ CF Year 1 40,000$ 5,000$ 70,000$ CF Year 2 40,000$ 5,000$ 70,000$ CF Year 3 40,000$ 5,000$ 70,000$ CF Year 4 40,000$ 5,000$ 5,000$ r 10% 10% 10%
Calculate PV, NPV, PI 3 Investment alternatives
System A System B System C Initial Cost 100,000$ 10,000$ 150,000$ CF Year 1 40,000$ 5,000$ 70,000$ CF Year 2 40,000$ 5,000$ 70,000$ CF Year 3 40,000$ 5,000$ 10,000$ CF Year 4 40,000$ 5,000$ 10,000$ r 10% 10% 10%
3 Investment alternatives Profitability Index (PI)
System ASystem BSystem C
Initial Cost 100,000$ 10,000$ 150,000$
CF Year 1 40,000$ 5,000$ 70,000$
CF Year 240,000$ 5,000$ 70,000$
CF Year 340,000$ 5,000$ 10,000$
CF Year 440,000$ 5,000$ 10,000$
r 10%10%10%
3 Investment alternatives
Profitability Index (PI)
Sheet1
| PV | = | C(1) | + | C(2) | + | ….. | C(n) | |||||||||
| 1+r | (1+r)^2 | (1+r)^n | ||||||||||||||
| C | $ 40,000 | |||||||||||||||
| r | 10% | |||||||||||||||
| Periods | 4 | |||||||||||||||
| Initial Investment | $ (100,000) | 40000 | + | 40000 | + | 40000 | + | 40000 | ||||||||
| 1.1 | 1.21 | 1.331 | 1.4641 | |||||||||||||
| $ 36,364 | + | $ 33,058 | + | $ 30,053 | + | $ 27,321 | = | $ 126,795 | PV | $126,794.62 | ||||||
| C | 10000 | |||||||||||||||
| r | 4.5% | |||||||||||||||
| n | 3 | |||||||||||||||
| Initial investment | 27000 | 10000 | + | 10000 | + | 10000 | + | |||||||||
| 1.045 | 1.092025 | 1.141166125 | ||||||||||||||
| $ 9,569 | + | $ 9,157 | + | $ 8,763 | + | PV | = | $ 27,490 | ||||||||
| OR | ||||||||||||||||
| r | 0.045 | Formula | ||||||||||||||
| Monthly Savings | -10000 | PV | $27,489.64 | |||||||||||||
| Periods | 3 | |||||||||||||||
| r | 10% | Formula | ||||||||||||||
| Monthly Savings | -30000 | PV | $184,337.01 | |||||||||||||
| Periods | 10 | |||||||||||||||
| 3 Investment alternatives | ||||||||||||||||
| System A | System B | System C | ||||||||||||||
| Initial Cost | $ 100,000 | $ 100,000 | $ 100,000 | |||||||||||||
| CF Year 1 | $ 40,000 | $ 25,000 | $ 65,000 | |||||||||||||
| CF Year 2 | $ 40,000 | $ 30,000 | $ 65,000 | |||||||||||||
| CF Year 3 | $ 40,000 | $ 45,000 | $ 20,000 | |||||||||||||
| CF Year 4 | $ 40,000 | $ 55,000 | $ 20,000 | |||||||||||||
| r | 10% | 10% | 10% | |||||||||||||
| 1 | ||||||||||||||||
| 2 | ||||||||||||||||
| 3 | ||||||||||||||||
| 4 | ||||||||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | PV | NPV | |||||||||||
| System A | $ 36,363.64 | $ 33,057.85 | $ 30,052.59 | $ 27,320.54 | $ 126,794.62 | $ 26,794.62 | ||||||||||
| System B | $ 22,727.27 | $ 24,793.39 | $ 33,809.17 | $ 37,565.74 | $ 118,895.57 | $ 18,895.57 | ||||||||||
| System C | $ 59,090.91 | $ 53,719.01 | $ 15,026.30 | $ 13,660.27 | $ 141,496.48 | $ 41,496.48 | ||||||||||
| Profitability Index (PI) | ||||||||||||||||
| 3 Investment alternatives | ||||||||||||||||
| System A | System B | System C | ||||||||||||||
| Initial Cost | $ 100,000 | $ 10,000 | $ 150,000 | |||||||||||||
| CF Year 1 | $ 40,000 | $ 5,000 | $ 70,000 | |||||||||||||
| CF Year 2 | $ 40,000 | $ 5,000 | $ 70,000 | |||||||||||||
| CF Year 3 | $ 40,000 | $ 5,000 | $ 10,000 | |||||||||||||
| CF Year 4 | $ 40,000 | $ 5,000 | $ 10,000 | |||||||||||||
| r | 10% | 10% | 10% | |||||||||||||
| 1 | ||||||||||||||||
| 2 | ||||||||||||||||
| 3 | ||||||||||||||||
| 4 | ||||||||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | PV | NPV | PI | ||||||||||
| System A | $ 36,363.64 | $ 33,057.85 | $ 30,052.59 | $ 27,320.54 | $ 126,794.62 | $ 26,794.62 | 27% | |||||||||
| System B | $ 4,545.45 | $ 4,132.23 | $ 3,756.57 | $ 3,415.07 | $ 15,849.33 | $ 5,849.33 | 58% | |||||||||
| System C | $ 63,636.36 | $ 57,851.24 | $ 7,513.15 | $ 6,830.13 | $ 135,830.89 | $ (14,169.11) | -9% |
Year 1 Year 2 Year 3 Year 4 PV NPV PI System A 36,363.64$ 33,057.85$ 30,052.59$ 27,320.54$ 126,794.62$ 26,794.62$ 1.27 System B 4,545.45$ 4,132.23$ 3,756.57$ 3,415.07$ 15,849.33$ 5,849.33$ 1.58 System C 63,636.36$ 57,851.24$ 52,592.04$ 3,415.07$ 177,494.71$ 27,494.71$ 0.18
Year 1 Year 2Year 3 Year 4 PV NPVPI
System A 36,363.64$ 33,057.85$ 30,052.59$ 27,320.54$ 126,794.62$ 26,794.62$ 1.27
System B 4,545.45$ 4,132.23$ 3,756.57$ 3,415.07$ 15,849.33$ 5,849.33$ 1.58
System C 63,636.36$ 57,851.24$ 52,592.04$ 3,415.07$ 177,494.71$ 27,494.71$ 0.18
1234
Costs
Hardware 10000100010001000
Software 13000300030003000
Services 2000100010001000
Benefits
Increased productivity 1000060006000
Lower Error rates 1500050005000
System A
1234
Costs
Hardware 10000100010001000
Software 13000300030003000
Services 2000100010001000
Benefits
Increased productivity 1000060006000
Lower Error rates 1500050005000
System A
0.08
Period1234
25000500050005000Total
PV Cost 1.081.16641.2597121.36048896
2314842873969367535,079
PV Benefits 0250001100011000
1.081.16641.2597121.36048896
021433.47058732.154658085.3283838,251
Benefit /Cost Ratio
System A 38,251 Benefit
35,079 Cost
Ratio 1.090
Subtract 38,251 from35,079 equals 3,172