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|D14:||Justification of Payoffs from Information Technology Investments|
The purpose of this paper is to set forth some of the most important principles to be applied when calculating the value of IT ROI. The paper presents a firm-level view of analysis and does not deal with questions how to justify individual projects or how to address the balancing of a diverse portfolio of projects that have different levels of risk or varying time horizons when one can expect payoffs. Those topics will be tackled in subsequent papers.
The important principles presented here are as follows:
1. The imperative to present ROI estimates in the context of generally accepted accounting and financial analysis methods.
2. The necessity to apply risk adjusted cash flow analysis for comparing investment alternatives.
3. The application of the concept of "residual value" whenever IT investments are expected to have long-term effects.
4. The importance to present proposals in terms of "Best", Expected and "Worst" cases so that corrective measures can be taken to focus management attention on timely preventive actions.
5. An emphasis that every IT budget request requires a summarization of the proposed spending as an investment portfolio. Corporate management will be less interested in discuss the merits of individual projects than to obtain an overall insight in of how and where money will be spent.
|The Role of ROI in I.T. Planning||9|
|The ROI Backlash||11|
|Quality of ROI Calculations||13|
|The "Intangible" ROI||14|
|The Uniqueness of ROI||15|
|ROI as a Test||16|
|The Microscope Test.||16|
|The Sight Test.||17|
|The Telescope Test.||18|
|The Survival Test||18|
|The Institutional Setting||18|
|Calculating a Firmís ROI Gain||20|
|Residual Value - A Long View||26|
|Calculating a Projectís ROI Gain||29|
|Observations About ROI Calculations||35|
|IT Portfolio Management||37|
|A Portfolio view of an I.T. Infrastructure||43|
|Table 1 - Balanced Score Card for Ranking Project Priority||19|
|Table 2 - Results of CFO Review of IT Budget Proposal||20|
|Table 3 - An Example of a Base Case Business Plan||21|
|Table 4 - Discounts from Sum of Payments Rise with Time and Risk||23|
|Table 5 - Net Present Worth of Pretax Income of Base Case||24|
|Table 6 - Proposed Improved Business Plan||24|
|Table 7 - Proposed Market Share Gains||25|
|Table 8 - Proposed Back-Loaded Plan||25|
|Table 9 - Base Case Must Consider Long Range Worth||27|
|Table 10 - The Net Present Worth of Cash Flows plus Residual Value||27|
|Table 11 - The Worst Case ROI Useful for Testing Assumptions||28|
|Table 12 - Exceptionally High ROIs to be Viewed with Caution||28|
|Table 13 - Simple ROI Calculations for a Short-Term Project||29|
|Table 14 - Partial View of the HP ROI Calculator||31|
|Table 16 - Partial View of Sungard Benefits Calculator||34|
|Table 17 - Partial View of Nucleus Research Consultants ROI Tool||35|
|Table 18 - Profile of Proposed IT Investment Portfolio||39|
|Table 19 - Proposed IT Investment Portfolio - I.T. Costs Only||40|
|Table 20 - Proposed IT Investment Portfolio - Full Costs||40|
|Table 21 - Financial Profile of Proposed IT Investment Portfolio||41|
|Table 22 - Proposed IT Investment Changes to Financial Projections||42|
|Figure 23 - Most of the IT Budget Absorbed in Infrastructure Spending||43|
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