AFM241 Chapter Notes - Chapter 7: Cash Flow, Capital Budgeting, Net Present Value
17 May 2018
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Chapter 7
7.1 Introduction – Pg 302
• We must find some way of evaluating IT investments
- ES investments are more elaborate investments, harder to evaluate
• Evaluating )T investment benefits and costs helps with
- Helps managers think carefully and quantify costs and benefits
- Makes managers aware that there are limited resources, resources should be allocated to
projects with highest payoffs
- Introduces element of accountability for benchmarking actual performance of IT
investments
• Evaluating )T investments, typical tools include:
- NPV: Present value of all cash inflows minus present value of all cash outflows
o Typically took for evaluating investment proposals
o Best for IT projects which are relatively large and their expected benefits/costs
stretch over several years
- IRR: Actual rate of return from an investment or the interest rate that makes the present
value of expected benefits equal to the present value of its costs
o Accounts for time value of money, but depending on cash flow a project may have
more than one
o Best for IT projects which are relatively large and their expected benefits/costs
stretch over several years
- ROI: Ratio of net benefits over the invested capital
o Takes into consideration the entire lifecycle of an investment, but it does not
account for the time value of money
o When need for detailed IT analysis is not very important- IT initiatives which are
relatively small in size and implementation time, and when expected costs as well as
expected benefits are clear
- Payback
o Looks at time it takes to recover the initial investment
o Tends to favor short-term projects
o Does not consider returns that occur after the payback period
o Ignores time value of money
o When need for detailed IT analysis is not very important- IT initiatives which are
relatively small in size and implementation time, and when expected costs as well as
expected benefits are clear
7.2 Capital Budgeting Analysis – Pg 304
7.2.1 Blue Bikes – ES Implementation
find more resources at oneclass.com
find more resources at oneclass.com
• Blue bikes updating its ES system with expected benefits
- 10% increase of profit margins to 60%
- 9% availability increase to 99%
- Days sales inventory reduced by 10
- 70% of increase in availability to sales
- 60% of increase in first year, remaining 40% in second year
7.2.2 Cash Flow
• Typical cash outflows include
- Upfront software payment
- Consulting and implementation costs
- Training costs
- Maintenance fees
• Typical cash inflows include
- Increased revenues
- Reduced costs
- Release in working capital
7.2.3 Blue Bikes Cash Inflows
Additional Units = (Pre-ES Units Sold)x(Increase in Availability)x(Conversion Rate)x(Achieved
Improvement in First Year)
Profit Margin Per Unit = (Price per unit – COGS per unit)/Price per unit
Sales=(Units Sold)x(Price per Unit)
DSI Reduction= (Target Reduction)x(Achieved Reduction 1st year)
Ending Inventory = (Cost of Goods Sold x DSI)/365
• Inventory reduction levels are incremental and affect only one year not multiple
(Read in book rest, Pg 309)
7.3 Limitations of Capital Budgeting Analysis Pg 311
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
7. 1 introduction pg 302: we must find some way of evaluating it investments. Es investments are more elaborate investments, harder to evaluate: evaluating )t investment benefits and costs helps with. Helps managers think carefully and quantify costs and benefits. Makes managers aware that there are limited resources, resources should be allocated to projects with highest payoffs. Introduces element of accountability for benchmarking actual performance of it investments: evaluating )t investments, typical tools include: Npv: present value of all cash inflows minus present value of all cash outflows: typically took for evaluating investment proposals, best for it projects which are relatively large and their expected benefits/costs stretch over several years. Ignores time value of money relatively small in size and implementation time, and when expected costs as well as expected benefits are clear. 7. 2. 1 blue bikes es implementation: blue bikes updating its es system with expected benefits. 10% increase of profit margins to 60% 70% of increase in availability to sales.
