Applying NPV, ROI – An example to guide IT strategist to evaluate IT investments

Case Study:

Opportunity A:   Your bank is looking at an optical character recognition (OCR) system to further automate the check processing function. Check processing is a time sensitive function. If outgoing checks miss daily clearing deadlines, the bank looses use of the money for one day. Since your bank clears over one million checks per day, this can be a substantial amount. The current system, based on magnetic ink character recognition (MICR) is reliable, but labor intensive. It requires large numbers of relatively low-level employees to encode each check with magnetic ink. The cost of this process is very high and scheduling the right number of people to meet fluctuating volumes is challenging.

The initial investment for the OCR systems is estimated to be $1,250,000 for hardware, $450,000 for packaged software, $300,000 for customized modifications to the software, and $200,000 for training. Additional ongoing costs over a five (5) year system life are estimated to be: Hardware Maintenance: ($200,000 per year for 5 years); Software Maintenance: ($250,000; $200,000; $175,000; $200,000; $175,000); Supplies: ($200,000 per year for 5 years).  Benefits over the five-year system life are estimated to be: Salary Reductions due to Staff Cuts: ($1,000,000; $1,100,000; $1,200,000; $1,300,000; $1,400,000);  Increased Revenue Due to Faster Check Collection: ($450,000 per year for each of the 5 years).

Opportunity B:  Your bank is looking at installing a new credit card processing system to
replace your aging mainframe system. Not only would the new system be less expensive to operate, but also there appears to be an opportunity to sell processing services to other banks that are looking to outsource this function. Your analysis of the credit card market suggests that there will be a continuing concentration in the industry as many small banks sell their portfolios to larger companies. You feel that a modern credit card processing system is essential if you are to compete effectively in this market.

The initial investment for this credit card system is estimated to be: $1,250,000 for initial software licenses;  $200,000 for customization of software; and $250,000 for training.  Ongoing costs over a 5 year life are estimated to be: License maintenance fees: ($110,000 per year for 5 years) and Software maintenance: ($550,000; $600,000; $650,000; $650,000; $700,000).  Benefits over the 5 year system life are estimated to be: Salary Reductions due to staff cuts: ($450,000; $500,000; $550,000; $600,000; $650,000) and New Revenues from Outsource customers: ($400,000, $450,000, $600,000, $700,000, $3,500,000).

Which alternative will you present to the IT Steering Committee and why?

::Analysis::

Note:

Present Value = Current value of cash inflow (C) at acceptable discounted rate or hurdle rate (r) at a specific time period t (year 1, t=1). Which is calculated as C_t/(1+r)^t

 

 

   1.3 Justification for the right alternative