Week 5 Project

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Understanding the Business Value of IS

Let us discuss the various ways in which IS can provide business value to a �rm. The categories of methods are traditional capital budgeting models, models based on strategic considerations, and models that measure productivity and pro�tability.

Traditional Capital Budgeting Models

Capital budgeting models determine if an investment in IT provides suf�cient returns to justify its costs. The main capital budgeting models are:

Accounting Rate of Return on Investment (ROI): Calculates the rate of return on an investment by adjusting the cash in�ow produced by the investment for depreciation. This gives the approximate accounting income that the project earned.

Cost-bene�t ratio: Calculates the return on capital expenditure by dividing total bene�ts by total costs.

Internal Rate of Return (IRR): Calculates the rate of pro�t or return that an investment is expected to earn.

Net Present Value (NPV): Calculates the amount of money an investment is worth, taking into account its cost, earnings, and the time value of money.

Payback method: Calculates the time required to repay the initial investment of a project.

Pro�tability index: Compares the pro�tability of investments by dividing the present value of the total cash in�ow from an investment by the initial cost of the investment.

After discussing the traditional capital budgeting models, let us focus on models based on strategic considerations.

Models Based on Strategic Considerations

Some models for evaluating IS investments use strategic and non�nancial considerations. They include:

Portfolio Analysis: Analyzes the portfolio of potential applications within an organization. The analysis helps determine bene�ts and risks and select among alternatives for IS. The management can determine the optimal mix of investment, reward, and risk for their �rm by balancing safer, lower-reward projects with riskier, high-reward ones.

Scoring Models: Decide among alternative systems based on a system of ratings for selected objectives. It evaluates two different ERP systems by measuring how well they will be able to meet the information requirements of the �rm.

Real Options Pricing Models (ROPM): Evaluate IT investments with uncertain returns by using techniques for valuing �nancial options. ROPM allows managers to systematically consider the volatility in the value of IT projects over time, the changing cost of implementation as interest rates or prices fall or rise over time, and the optimal timing of the investment.

Knowledge Value-Added Approach: Uses knowledge input in IT to change business processes. Knowledge input is measurable in terms of the learning time required to master a new process and then estimate a return on knowledge.

Pro�tability and Productivity: Uses multifactor productivity, which is a measure of the ef�ciency of the company, to convert input to output. It refers to the amount of labor and capital required to produce a unit of output.