Approaches used to evaluate IS Investments

28 Oct

Continuing from my previous blog, i mentioned that despite the diffculty, the task of evaluating IT investments is necessary. And knowing which approaches to use and when to use them are the important first steps. Not every evaluation method works in every case. Depending on the assests employed, the duration of the project, and any uncertainity about implementation, one method may work better than another. Below are number of  approaches used to evaluate IS investments.

Some of the valuation methods used are:

Return on investment (ROI): The percentage rate that measures the relationship between the amount the business gets back from the investment and the amount invested. Although ROI is popular and easy to use and understand, it lacks sophistication in assessing intangible benefits and costs. For eg. ROI can be used when detailed analysis is not required, such as when a project is short lived and its costs and benefits are clear.

Net present value (NPV): NPV accounts for the time value of money. After discounting and then adding the inflows and outflows, a positive NPV indicates a project should be undertaken, as long as other IS/IT investments do not have higher values.

Economic value added (EVA): EVA accounts for opportunity costs of capital to measure true economic profit and revalues historical costs to give an accurate picture of the true market value of assets. For e.g. when a project lasts long enough that the time value of money becomes a factor, NPV and EVA are better approaches to use.

Payback analysis: This is a simple popular method that determines the payback period, or how much time will lapse before accured benefits overtake accrued and continuing costs.

Internal rate of return (IRR): Calculation is made to determine the return that the IS/IT investment would have, and then it is compared to the corporate policy on rate of return. If IS/IT investment’s rate of return is higher than the corporate policy, the project is considered a good investment.

Weighted scoring methods: Costs and revenues/savings are weighted  based on their stategic importance , level of accuracy or confidence, and comparable investment opportunities

Prototyping: A scaled-down version of a system is tested for its costs and benefits. This approach is useful when the impact of the IT investment seems unclear.

Game theory or role-playing: These approaches may reveal behavioural changes or new tasks attributed to a new system.

Simulation: A model is used to test the impact of a new system or series of tasks. This low-cost method surfaces problems and allows system sensitivites to be analysed.

(Pearlson and Saunders, 2009).

I also read about  portfolio approach during my research as one of the approaches for evaluating IS investments but lucid21 has written about it.

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