Activity7, Activity8,

AltSol#2

example)>
Executive Sponsor:
Brief Description of Benefits:

) Summary of Comparison Results Payback System Discount ROI NPV in Years Life (Yrs) Rate Alt. Solution #1: 1

% $3

,

36

2

2

1 5.5 0.05
All costs and benefits are estimated from the baseline. Because of this, the baseline is represented by zero dollars in the chart. The baseline is made up of the costs and benefits that exist before the project to implement the proposed solution begins. If the project will add a net cost in a year, it appears as a negative (below the baseline) in the chart. If the project will add a net benefit, it appears as a positive (above the baseline) in the chart. The tables above and below and the chart to the left show the life cycle results from the two projects. Net Financial Gain or Loss by Year in Constant Dollars CurYr CurYr+1 CurYr+2 CurYr+3 CurYr+4 CurYr+5 CurYr+6 CurYr+7 AltSol#1

0 $83,429 $1

5 $107,815 $102,603 $0

$0
AltSol#2

$0 $0
Baseline

$0 $0 $0 $0 $0 $0 $0 $0
No

te: All financial comparison data on this page are in “constant dollars,” which means the dollar figures are adjusted in terms of the value of today’s dollar. Copyright ©

05-2010 IT Economics Corporation

. All rights reserved. This material is copyrighted and may not be copied or distributed without written permission from IT Economics Corporation. Certain colleges and universities have permission to use the material in specific courses, which permission may be withdrawn at the discretion of IT Economics Corporation. Students enrolled in such a course may use the material only in connection with meeting course requirements as specified by the course instructor and may not use or distribute the material for any other purpose.

Comparison

AltSol#1
AltSol#2
Baseline

AltSol#1

1

1

data only in the Step 2 yellow spaces. All other cells are locked. All calculations are automatic.

1

1

1

probability that a $

0 benefit will be achieved will be automatically calculated at

%

of $1000, or

.) Enter probabilities by category (savings, productivity improvements, and cost avoidances) and by year. Use an appropriate life cycle period, but not more than 7 years.

0

0

s

5.5

0 0 0 0 0 0 0 168,000

s

0 0 0 0 0 0 0 6,000

0 0 0 0 0 0 0 0 0

0 0 0 0 0 10,000

0 0 0 0 0 0 0 1,800 2

0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 4,700

0 0 0 0 0 0 0 0 0

project costs

0 0 0 0 0 0 0 12,300

0 0 0 0 0 0 0 202,800

0 0 0 0 0 0 0 0 0

0 0

0 0 0 0 0 0 0 0 0

0

1,200 0 0

1,200

0 0

2,250 2,350 2,450 2,550 2,650 0 0

1

68,000

136,000 136,000 136,000 0 0

2

0

10,000

20,000 0 0

3

0 0 0 0 0 0 0 0 0

4

0 0 0 0 0 0 0 0 0

85% 85% 85% 85% 0% 0%

90% 90% 90% 90% 0% 0%

133,600 0 0

Current Year

0.05

Constant Dollars Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total

202,800 0 0 0 0 0 0 0 202,800

1,200

0 0

204,000 2,143 2,132 2,116 2,098 2,076 0 0

0 0

0 0

54,400

0 0

-$149,600 $83,429 $110,884 $109,405 $107,815 $102,603 $0 $0 $364,536

No No

Paid Back Paid Back Paid Back Paid Back Paid Back Paid Back

0% 0%

$364,536

0 1 2 3 4 5 6 7

$0 $0 $0 $0 $0 $0

$0 $0 $0 $0 $0 $0

http://www.iteconcorp.com

AltSol#2

0.5

1

Copyright © 2005-2010 IT Economics Corporation http://www.iteconcorp.com 1

1

Calendar Year 1

0

0 0 0 0 0 0 0 99,800 5.5

– Hardware purchases 0 0 0 0 0 0 0 0 0

10,000 0 0 0 0 0 0 0 10,000

– Facilities 0 0 0 0 0 0 0 0 0
– Travel 4,700 0 0 0 0 0 0 0 4,700
– Legacy phase out costs 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 9,000

0 0 0 0 0 0 0 125,300

Cost of Operations From Baseline
– Operations staff (with overhead) 0 0 0 0 0 0 0 0 0

– Security and privacy 0 0 0 0 0 0 0 0 0

12,000 12,000 12,000 12,000 0 0

12,000 12,000 12,000 12,000 12,000 0 0

Estimated Benefits From Baseline

68,000 102,000 136,000 136,000 136,000 136,000 0 0 714,000

0 5,000 10,000 20,000

30,000 0 0

0 0 0 0 0 0 0 0 0

5,000 20,000 20,000

25,000 25,000 0 0

– Quality improvements 0% 90% 90% 90% 90% 90% 0% 0%
– Other increases in revenues 0% 0% 0% 0% 0% 0% 0% 0%

95% 95% 95% 0% 0%

173,150 0 0

Step 3. You need to take no action in this step. It is informational (see note at right). It assumes that the current year is also the base year (the start of the project). The base year is used as the starting year in the conversion to the constant dollars showing in Step 4. The discount rate is used to calculate constant dollars–that is, dollars that reflect the time value of money for the specific organization. Current Year Base Year Discount Rate Note: Normally, you would enter the current year, base year, and discount rate. They are provided here for the sake of simplicity.
[Actual Current Year would be entered] [Actual Base Year would be entered] 0.05
Calendar Year
Step 4. Conversion to Constant Dollars. You need take no action in this step. The Constant Dollars and Totals are automatically calculated from the discount rate identified above in Step 3. Each organization has its own discount rate, which a person must use when making constant dollar (present value) calculations. The federal government uses a discount rate established by the Office of Management and Budget. Constant Dollars Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total
Estimated Risk-Adjusted Costs
Investment Cost

10,884

0 0

Estimated Risk-Adjusted Benefits

0 0

8,163

0 0

– Other increases in revenues 0 0 0 0 0 0 0 0 0

0 0

0 0

Current Year Current Year+1 Current Year+2 Current Year+3 Current Year+4 Current Year+5 Current Year+6 Current Year+7 Total

0% 0% 287%

The numbers in this row are used as exponents in above PV calculations 0 1 2 3 4 5 6 7
1Productivity benefits result from either or both (a) reduced labor cost requirements per unit of output (e.g., new technology that requires less people to perform the same
amount of work; (b) cost savings from reduced need for non-labor resources per unit of output (e.g., new technology that reduces non-labor costs).

increase market share.
4Cost avoidance or reduction may be achieved, for example, by implementing a system that prevents losing a competitive edge, prevents loss through security breaches,
improves disaster protection, avoids the need to buy certain hardware and software, or avoids the need to purchase software licenses, among other possibilities.
Caution: Be careful not to double-count any cost or benefit. If the cost or benefit dollars are counted in one row,
they must not be included in any other row in the table.
Note: This is demonstration software. This software and associated documentation are provided “as is” without warranty of any kind. Moreover, IT Economics Corp. does not
make claims regarding the suitability or performance of this software for any specific purpose. The entire risk arising out of the use or performance of this software and
documentation remains with the person or organization that uses them. IT Economics Corporation shall not be liable for any damages whatsover arising out ot the use of
this software. By using this software, you agree to these provisions.
Copyright © 2001 – 2010 by IT Economics Corporation. All rights reserved.

http://www.iteconcorp.com

UseGuide

per year. You enter $10,000 for that year in the worksheet.

DataExample

: The phases and tasks in this project as well as the costs by phase are as follows:

*

– Software purchases

60 – Hardware purchases

100 – Communications

– Travel

$300 – Legacy phase out costs

– Other project costs $300

Labor Hours – Software purchases

60 – Hardware purchases

80 – Communications $300

40 – Facilities

– Legacy phase out costs

$6,000 – Other project costs

$0

Labor Hours – Software purchases

60 – Hardware purchases

80 – Communications

100 – Facilities

100 – Travel $300

– Other project costs

Other costs (Misc.): $0

Labor Hours – Software purchases

– Hardware purchases

160 – Communications $600

50 – Facilities

50 – Travel $200

20 – Legacy phase out costs

$10,000

– Other project costs

$10,000

$1,000

$10,000

$1,200

$202,800

$1,200

$168,000

$202,800

$1,200

$204,000

Comparative Analysis of Alternative Solutions
IT Acquisition Template 8

Proposal Assessment

Criteria

Leading organizations establish a set of “IT investment assessment criteria” that encompasses financial
value, non-financial value, and risks. They use this set of criteria to evaluate proposed alternative
solutions, before they become proposals, as well as to evaluate fully-developed proposals.

The IT investment assessment criteria are higher level requirements that supplement the requirements
specified to solve the problem. In other words, a proposed solution must not only solve the problem
(that is, meet all the problem solution requirements), but it must do so in a way to satisfy the IT
investment assessment criteria. In this way, the “best solution” is identified—the one that will not only
solve the problem but contribute the most to the organization in doing so. The IT investment
assessment criteria takes the form of a standard set of high level assessment criteria used organization-
wide.

In Template 6 (risk analysis), you already used a set of risk criteria similar to those used by many
organizations, and you will use those criteria again here along with other criteria in performing a cost-
benefits-risks tradeoff analysis to select the best alternative solution.

Standard Set of Assessment Criteria

Having a standard set of high level IT investment criteria for use organization-wide makes the following
possible:

• All proposed IT investments can be subject to the same established set of decision criteria,
rather than each proposal having individually created criteria

• The various components of the organization can know in advance what high-level criteria must
be met in order for their internal proposal to be approved or for a proposal submitted by an
external source to be selected. This helps internal groups as well as external source to prepare
better proposals.

• Because all proposals must meet the high-level criteria as well as the solution criteria, more
proposals will be received that are responsive to the organization’s priority goals and objectives,
including alignment, timeliness, and benefit-cost-risk standards.

• The organization’s investment review committee can use the same set of criteria to evaluate
and compare (a) internally-generated alternative solutions to a problem, (b) internal proposals
that compete with other internal proposals, and (c) proposals submitted by external sources.

Note the fourth point above. One use of the set of high level criteria is to evaluate alternative solutions
to a specific performance problem in order to identify the best solution. (This is how you will use
Template 8). In leading organization, the various proposal teams use the high-level criteria to evaluate
their own alternative solutions to identify the best one. They will develop the best solution into a
proposal that will be submitted to an executive investment review committee. The committee receives
proposals from various parts of the organization and uses the same set of high level criteria to evaluate
the competing proposals submitted to them. The committee decides which among those submitted are
best for the organization and should be funded.

If a request for proposal has gone out, the proposals received will first be reviewed by the proposal
selection committee and then the proposal that this committee selects will be sent to the executive
review committee. This proposal will have to compete with all of the other proposals for funding. The
investment review committee, using the established high-level criteria, reviews the various proposals
and decides which should be funded. The established high-level criteria are equally effective evaluating
both internally-prepared proposals and externally prepared proposals. The Clinger-Cohen Act of 1996
requires federal agencies to establish such a set of IT investment criteria for organization-wide use in
evaluating and selecting the IT proposals to fund.

Using Template 8

Template 8 is an example of a scoring matrix that uses research-based high-level criteria “categories” to
organize a standard set of high level IT investment assessment criteria. The categories and their
definitions are based on research involving successful and unsuccessful IT acquisitions. Although the
criteria categories and their definitions have broad applicability to organizations, the specific criteria
within a category will vary to reflect the needs of the particular organization.

For example, the category “Strategic Match” is defined as “The degree of match of the proposed
solution with the strategic goals and objectives of the organization.” This definition is applicable to any
organization and its proposals, but organizations have different goals and objectives so the specific
criteria they will include in this category will vary. Here are some examples of goals that illustrate how
diverse the goals can be. An organization is likely to have some of these goals but not all of them.

Examples of Organizational Goals

Maintain a competitive
edge

Gain leadership in the
field

Increase market share

Create new products

Increase number of
partners

Generate brand
recognition

Obtain international
business

Increase revenues

Improve customer service

Increase productivity

Increase efficiency

Reduce cost

Be environmentally
friendly

Many, many other
possibilities

Value and Risk Criteria, Weights, and Rating Range

Usually the criteria are divided into Value criteria categories and Risk criteria categories, as is done in
Template 8. The term “value” is used, rather than “benefit,” because value is more encompassing. In
terms of financial value, it is what it is left after the cost is taken into account. For example, if a proposal
will generate $2 million in income and its cost (investment) is $1 million, the financial value of the
proposal is $1 million.

There are also “non-financial” values, which cannot be easily quantified in dollars. For example, keeping
customers happy is an important non-financial value; they may not buy more products or services (i.e.,
increase the ROI), but they are likely to stay as customers, which is a value to the organization.
The template also gives a certain weight to each criteria category. The amount of weight given is
intended to represent the relative importance of that criteria category to the particular organization.
Most organizations give ROI/NPV the highest Value weight, though sometimes (mainly in government
agencies) Strategic Match is given the same or even a higher weight.

With this template, the rating range for each criteria category is from 1 to 5, with 1 being the lowest
score and 5 being the highest score.

Defining Rating

Scores

Organizations determine and document the meaning of each rating for each criteria category. For
example, a “1” rating on ROI/NPV would be for a proposal with a low ROI over the next three years and
a low or modest NPV. A “5” rating on ROI/NPV might be for a proposals with an ROI forecast of 300% or
more and a large NPV. Organizations define, document, and distribute a guide explaining the meaning of
each rating. In this way, a each rating from “1” to “5” (if a 5-point scale is used) has the same meaning
throughout the organization.

The rating on a criteria category is multiplied by the weight given to that category to come up with the
proposal’s weighted score for a criteria category. For example, if the category ROI/NPV has a weight of 8
and a proposal receive a “5” rating on ROI/NPV, the 5 rating would be multiplied by the weight of 8, so
the entry in the Weighted Score cell would be 40 (8 x 5 = 40).

Criteria
Category

Category
Weight

Proposal
Rating

Weighted
Score

ROI/NPV 8 5 40

The Value criteria category given the most weight in Template 8 is ROI & NPV. All of the other Value
criteria in the template are non-financial – that is, they are not easily measured in financial terms.
However, they are measurable in non-financial terms. For example, Quality of Worklife can be measured
via a survey of the staff expected to use the proposed system. If they respond that they believe the
proposed system will enrich their jobs, broaden their skills, and increase their pay, the proposal would
be rated high on Quality of Worklife. If the survey shows the opposite results, there would be a low
rating on Quality of Worklife. (A low rating for a category is a sign that the proposal needs to be
improved or rejected.) Of note, a high rating in this category can lead to future increases in ROI/NPV.

The Risk criteria category given the most weight in Template 8 is Organizational Risk. This type of risk is
the most common cause of project failures. Many criteria are normally included in this category. The
objective is to identify the presence of Organizational Risk in a proposal before it is selected for funding.
Then, depending on the amount and type of risk, either eliminate the proposal or modify it to avoid as
much risk as possible and mitigate the risk that cannot be avoided. The result should be less project
failures.

Risk Criteria Used Again

As mentioned earlier, this template uses the same Risk Criteria used in Template 6 in an earlier
“screening out” of evaluation of alternative solutions. As a result, you know much about the risk
characteristics of the two solution alternatives you selected. You may wish to refer to your results in
Template 6 as an aid to determining the risk inputs for Template 8. However, you have more
information about your alternatives now, so do not be reluctant to change your risk ratings for Template
8 if you believe you should.

You will also need the results from the Economic Analysis of your two alternatives (Template 7) as inputs
for Template 8.

Definitions of the Value and Risk Criteria Categories Used in Template 8

How are the Value and Risk criteria categories defined? Here are the definitions of the criteria used in
Template 8.

Value Criteria

1. ROI and NPV: The relative financial return on investment (ROI) and the net present value (NPV)
of this investment compared with competing investments

2. Strategic Match: The degree of match of the proposed solution with the strategic goals and
objectives of the organization.

3. Competitive Response: The extent to which this proposed solution is as good or better than
what competitors are doing.

4. Definitional Certainty: The degree to which sufficient reliable data are available to enable an
accurate definition of the problem and/or the future environment in which the proposed
solution must function.

5. Executive Support: Strength and likelihood of continued executive support (e.g., do some
executives oppose this solution).

6. Quality of Worklife: The extent to which it will improve the quality of worklife for employees
and others who will staff the activities.

7. Enterprise Architecture: The degree to which it supports the enterprise architecture plan
(interoperability, direction of growth, etc.)

Risk Criteria

1. Organizational Risk: Extent to which the culture and/or policies and practices of the
organization may present problems. Extent to which there may be insufficient buy-in, support,
or understanding on the part of key stakeholders (e.g., affected managers, employees,

customers). Extent to which employees with the required knowledge and skills may be
unavailable when needed to support the project and/or the implemented system.

2. Infrastructure Risk: The extent to which it may negatively affect the organization’s IT and non-IT
infrastructure (e.g., will it slow down other processes, reduce needed flexibility, place unusual
work demands on some groups?).

3. Information Security and Privacy: The extent to which it deviates from or negatively effects the
established standards and requirements for information security and privacy.

4. Complexity Risk: Degree of complexity of the proposed solution and/or which will be required
of the implementation project.

5. External Risk: The extent to which external risks pertain to this solution (e.g., risks associated
with strategic partners or with vendors or with outside overseers or interest groups, negative
impacts on the environment, possible incompatibility with law or regulations).

Benefits of Template 8

Having a single set of high level criteria and weights for evaluating alternative proposed solutions as well
as proposals from contractors has many advantages for an organization.

• First, it means that the same high-level criteria will be used with all proposals so that proposals
can be compared. If separate criteria were used for each proposal, the proposals could not be
compared.

• Second, it increases the reliability and validity of the proposal ratings. Executives, proposal
teams, and other stakeholders gain experience and expertise using the high-level criteria.
Executives see the value of the ratings in the results produced (e.g., cost savings, improved
organizational performance, less risk).

• Third, proposal and acquisition teams use these standard high-level criteria to evaluate
alternative proposed solutions in order to select the best candidates to become formal
proposals—they know that proposed solutions that have high ratings on the criteria have the
best likelihood of being funded.

• Fourth, the executive investment review committee uses the same high-level criteria to evaluate
the proposals it receives. In other words, everyone is using the same high-level criteria.

• And fifth, the high-level criteria can be modified as needed to match the changing needs of the
organization. For example, the Value criteria category “Strategic Match” refers to the extent to
which a proposal is aligned with the strategic goals of the organization. If the strategic goals
change, the alignment must be with the new strategic goals, not with the old ones.

Your Use of Template 8

Use Template 8 and its criteria category definitions to evaluate your alternative solutions in order to
determine which one is best and should become the basis of a request for proposal. In evaluating your
alternatives, do the following:

• Use the weights provided in the template.

• Use a rating range of 1 to 5 in evaluating an alternative relative to a criterion, with 5 being the
highest rating. Remember that a “5” rating on a Value Criterion is good but a “5” rating on a Risk
Criterion is bad.

Remember, in Template 4, the top priority risks were given low numbers, such as 1 (highest priority) and
2 (second highest priority). In this template, high numbers are used to indicate much value or much risk,
depending on whether value or risk is being evaluated.

IT INVESTMENT ASSESSMENT RATING MATRIX

Solution
Alternative #1

[Delete this note and enter the alternative’s name and brief description]

Solution
Alternative #2

[Delete this note and enter the alternative’s name and brief description]

Value
Assessment

Criteria

Criterion
Weight

Alternative #1
Ratings

Alternative #1
Weighted

Scores

Alternative #2
Ratings

Alternative #2
Weighted

Scores
ROI and NPV 8

Strategic
Match

4

Competitive
Response

2

Definitional
Certainty

2

Executive
Support

2

Quality of
Worklife

1

Enterprise
Architecture

1

Total
Weighted

Value Score

Risk

Assessment
Criteria

Criterion
Weight
Alternative #1
Ratings
Alternative #1
Weighted
Scores
Alternative #2
Ratings
Alternative #2
Weighted

Scores
Organizational

Risk
6

Infrastructure
Risk

4

Information
Security

4

Complexity
Risk

3

External Risk 3

Total
Weighted
Risk Score

Based on benefits-costs-risks tradeoffs, the best solution alternative from among those above is:

[Enter Name of Best Solution]
Template 8. IT Investment Assessment Rating Form

Highest Possible Scores.

Since the weights for the Value criteria total 20 and 5 is the best rating in each Value criteria category,
the highest weighted Value score for an alternative solution is 100 (an alternative would need to get a
“5” rating in every category).

Similarly, the weights for the Risk criteria add up to 20 and 5 is the worst rating in each Risk criteria
category. Therefore, the worst weighted Risk score is 100. A 100 score for Value is good, but a 100 score
for Risk is bad. No, you do not subtract the Risk score from the Value score, which would be mixing
apples and oranges. Incidentally, some organization regularly did this before realizing that it is illogical
and resulted in poor selections of proposals.

Selecting the Best Alternative

The selection of the best solution from the two or three (or more) that you assess can involve many
value-risk tradeoffs. Is it better to have greater value with greater risk or lower value with lower risk? It
depends on the organization, its goals, problems, and other considerations. Organizations in highly
competitive environments are more likely to select an innovative high payoff solution with more risk
than a run-of-the-mill low payoff solution with little risk. Government agencies tend to accept less risk
than commercial organizations. In your case, you need to select the alternative solution that you believe
is on balance the best to solve your problem. –and you should be prepared to defend your choice with
evidence and fact-based assumptions.

After you have made your decision, enter the name of the selected best solution alternative in the space
provided in the template.

IMPORTANT NOTES:

1. This template should be used with a Microsoft Word (or other word processor) document. It should

not be used in an Excel worksheet because this is not an appropriate medium for transmitting the
document to others or for printing it for distribution.

2. The template is adjustable. After the template is copied to a Word document, replace the sample

entries in the cells with your own information. You can change the length and width of the template
and its cells after you copy the template to your document. If you put your cursor on a line in the
template, the line can be moved horizontally or vertically, depending on the line, to best fit your
information. There is no need to color any of the cells in your Word version, though color is used in
the example above.

Economic Analysis of Alternative Solutions
IT Acquisition Template 7

Introduction

Economic analysis is a management tool that assist in determining, analyzing, and documenting the
financial costs and financial benefits of alternatives. The product of the economic analysis of an IT
acquisition alternative solution is a projection of the risk-adjusted financial return on investment (ROI)
and the net present value (NPV) of the investment. The material below discusses the concepts
underlying economic analysis. At the end, it provides a link to an economic analysis worksheet that
applies the concepts and generates risk-adjusted ROI and NPV figures for an IT acquisition alternative or
a proposal.

NPV Versus ROI

Comparisons of the ROI and NPV of the competing alternative solutions will identify the alternative that
is most advantageous from a financial standpoint. Both ROI and NPV are used in making the
comparisons because they have different meanings and both provide valuable information for the
decision makers. ROI is a ratio that compares two quantities, such as investing $3 million and receiving
$5 million in return in terms of current dollars over a five-year period. This is an ROI of 67% (i.e., net gain
divided by the cost, or $2 divided by $3, where both the net gain and the cost are in today’s dollars).

NPV, on the other hand, is a figure that depicts the present value of the projected future stream of
benefits and costs. It can determine, for example, that the value of an IT investment over, say, the next
five years is, in terms of today’s dollars, $2 million more than its $3 million cost. In other words, the $3
million investment is expected to produce an NPV (net gain) of $2 million in terms of today’s dollars.

Which is better, an ROI of 67% or a NPV of $2 million? With the example given here, there is no
difference. But there is usually a difference. For example, it is possible to get a 67% return on a $100
project, so telling us that the return will be 67% does not give us enough information. Similarly, the NPV
figure of $2 million does not by itself tell us the rate of return we can expect on the dollars invested. We
need both the ROI and the NPV to get a proper financial picture. When the ROI and NPV are computed
using the same set of data, we will know both the rate of return as well as the total amount of net gain
that will be produced in terms of today’s dollars.

Providing Data for the Economic Analysis

Generally, when an alternative solution is identified, its benefits, costs, and risks are documented in
some detail. The cost information as well as insights on risks can be generated through the preparation
of a work breakdown structure for each alternative solution. The economic analysis, using information
from the WBS and its financial documentation for each alternative solution, can be used to identify the
solution expected to generate the best financial return.

Risk Data and Risk Adjustments

The ROI and NPV generated by the economic analysis need to be “risk-adjusted” to take into account
the probability that not all of the financial benefits may be realized. Template 6 enabled you to perform
a risk analysis of the alternative solutions. Now the question is how will the risks identified for an
alternative solution (taking into account the planned risk mitigation) likely to affect the benefits
expected from implementing that alternative solution. In general, the effect of risk on the expected
benefits is a matter of informed judgement.

Template 7 takes the form of an economic analysis worksheet that you can download, as provided in the
week 5 content area. A separate Economic Analysis is prepared for each alternative solution. In making
entries in a worksheet, decisions need to be made on how each type of expected financial benefit will be
affected by risk in each year of the projected life cycle. These risk-estimate inputs enable the Worksheet
to calculate risk-adjusted benefits over the life cycle of the project.

Benefits and Costs Data

Benefits Data

Template 2 summarized the new capabilities or functionalities that any solution to the problem must
satisfy. These are important benefits of a satisfactory alternative solution. Each alternative solution must
satisfy these requirements but each alternative solution may have other benefits beyond those new
capabilities or functionalities. These benefits need to be identified and quantified in financial terms. The
financial benefits data can then be entered into the Economic Analysis Worksheet for the life cycle of
the IT system.

Cost Data

The Economic Analysis Worksheet also require cost data for the life off the IT system. You will use the
cost information generated in the preparation of the work breakdown structures (Template 5). There
are a number of approaches to improving the reliability and validity of cost estimates and projections,
but they are beyond the scope of your present course and this activity. Estimating and projecting cost is
often one of the weakest aspects of IT acquisition planning. Sometimes in the zeal to get a proposal
approved, costs are minimized, overlooked, or hidden in biased and faulty assumptions. Sometimes it is
simply a lack of knowhow. Organizations that implement a professional approach to estimating and
projecting cost benefit in many ways, not the least of which is more effective project management.

Selecting a Common Life Cycle Period

The same number of life cycle years should be used for each of your alternative solutions when making
entries in the Economic Analysis Worksheets. If a life cycle of three years is used for one alternative
solution, a three-year life cycle must also be used for the other alternative solution.

The same number of years for the life cycle is used for every alternative solution so they have a common
period over which results can be compared. Usually, this means using the number of years equivalent to
the alternative with the shortest life cycle (often three or four years). However, the selection of the life

cycle period to use must be done with good judgement because alternatives often have different years
when they have their peak payoffs.

For example, if one alternative has a 3-year life cycle with its peak payoff in years 2 and 3, and a second
alternative has a 4-year life cycle with its peak payoff in years 3 and 4, some will argue that it would not
be fair to use a 3-year period to make a comparison. Could a 4-year or 5-year life cycle period be used
for both alternatives? The answer is yes, but then it will be necessary to provide 4 or 5 years of data for
each of the alternatives. A decision will need to be made to select the number of years that provides
the best comparison, whether it is 3, 4, or 5 years.

Where does one get the data for years 4 and 5 when one of the alternatives has, say, a 3-year life cycle?
One approach is to continue the shorter-life alternative past its operational “Obsolescence” date by
using the year 3 data for year 4 and, if needed, for year 5, with some adjustments if needed. The
adjustments can include any added cost and or changes in the benefits that are likely to occur in years 4
and 5.

The important point is that the comparisons of the alternative solutions need to be made over the same
period of time.

Economic Analysis Workbook

You can download the Economic Analysis Workbook (Template 7) from the list of resources. The
Workbook contains five worksheets. Worksheets 1, 2, and 3 contain examples of data that were entered
for two alternative solutions. Worksheets 4 and 5 explain how the data were generated for the
alternative solution presented in worksheet 2. You may find this helpful in developing or confirming the
data that you should enter for your two alternative solutions. If you had difficulty determining the costs
for your work breakdown structures, the explanations in worksheet 5 should be especially helpful.

After you have studied the examples provided on worksheets 2 and 3, you can replace the sample data
with the data for your own two alternative solutions. The worksheets will calculate automatically, as will
the comparison information on worksheet 1. In other words, the chart and tables on worksheet 1 will
now compare your two alternative solutions based on the information you entered.

The cells of the worksheets are “locked” except for those you need to use to enter your data. The locked
cells contain the formulas for calculating the worksheets and this is a way of protecting them from
accidental modification.

If no entries are made for a specific year in the worksheet, that year is ignored. The instructions in
worksheets 4 and 5 explain this.

The Workbook also explains that all costs and benefits are entered in terms of today’s dollars. If an
alternative solution will increase maintenance costs by, say, $500 per year for the next three years, that
is the figure you enter. On the other hand, if the maintenance costs will increase by 10% per year over
the next three years, you enter $500 for the first year, $550 for the second year, and $605 for the third
year. The worksheet takes care of all calculations, including adjustments for the time value of money for
these and other entries.

You must also enter the benefits that an alternative solution is expected to generate and the probability
that each type of benefit will actually be received. For example, if an alternative solution is expected to
add $100,000 per year in improved productivity, you would enter the $100,000 and also the percentage
of the $100,000 expected to be actually achieved each year. It could be 70% in the first year after the
project ends and 95% in the subsequent years. You would enter the 70% and the 95% figures in your
worksheet. You need to determine and assign the probability figures (the percentages) based on the risk
analysis you did for each alternative solution. These probabilities are necessary so the worksheet can
produce a risk-adjusted, discounted (by the time value of money) ROI and NPV for your alternative
solution.

As you may recognize, the worksheets use a relatively simple and practical way of adjusting for risk.
There are more sophisticated ways, including the use of Monte Carlo simulations based on probability
distributions (such as the triangular distribution). If you wish, you can do research to obtain more
information about probability distributions and Monte Carlo simulations.

Downloading the Workbook

When you download the Economic Analysis Workbook, take a little time at first to read the instructions
and study the examples. Then it is usually a good idea to enter zeros in all the data cells before you start
entering your own data into a worksheet. This will erase the example in the worksheet and you will
know that all the data entries are your own.

NOTE: Each page of the Workbook is designed so that it will print on one Word Document page. Do
not change these settings, since some instructors print each Workbook for grading. The results of the
Economic Analysis of the two best alternative solutions serve as input to the Template 8 analysis,
which determines which of the two is the most advantageous solution.