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Quantifying your business case Financial Attractiveness

January 10, 2008

Several approaches can be taken to determine the financial attractiveness of an IT investment, but I recommend that you use the metrics that are prevalent and trusted in your industry and your business. Remember that it is important to speak the language of your business to

Criterion Explanation
Net present value (NPV) NPV is a calculation that weighs an investment against its payback over time. The calculation demands four estimates: payback amount, payback period, a discount rate, and the investment amount. Negative NPVs can and do occur, both when paybacks are simply less than the investment or when paybacks are overridden by the discount factor, which is essentially the cost of money over time.
Payback period Period between initial investment and recovery of the total investment.
Level of investment Total investment required – allows an assessment of how many investments can be made against a particular budget. Includes both initial and life cycle costs.
Option Value Potential future value not reflected in NPV.
Cost/Benefit Ratio Total costs / total benefits. The cost/benefit ratio does not capture discount rates, but rather provides a simple ratio of all costs divided by all benefits. Smaller numbers are favorable.
ROI Net benefits plus investment costs/investment costs. Net benefit is benefit less operating costs. The number 1 indicates break-even. Larger numbers are favorable.
Internal Rate of Return (IRR) The actual rate of return (projected or realized) of the investment, taking into account the time value of money. (The IRR is the discount rate that makes an investment exactly equal to its payback over time).
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