Turn to Part C of the Systems Analyst’s Toolkit and review the concept of net present value (NPV). Determine the NPV for the following: An information system will cost $95,000 to implement over a one-year period and will produce no savings during that year. When the system goes online, the company will save $30,000 during the first year of operation. For the next four years, the savings will be $20,000 per year. Assuming a 12 percent discount rate, what is the NPV of the system?
What will be an ideal response?
An NPV analysis follows:
Notice that the NPV is a negative 13,970. In this example, what looked like an attractive project turned out not to be economically feasible. Why is this so? If no adjustment factor were used, the total benefits would exceed the total costs by $15,000. The primary reason for the negative outcome is the time value of money. Students should recognize that the $95,000 in costs would have to be spent up front, and paid for with today’s dollars. The benefits, on the other hand, would not be realized immediately and were worth less in terms of today’s dollars. This is a good example of the importance of NPV analysis.
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