Return On Investment

Return On Investment Analysis

Return on Investment (ROI) analysis is one of several approaches to building a financial business case. The term means that decision makers evaluate the investment by comparing the magnitude and timing of expected gains to the investment costs.

Decision makers will also look for ways to improve ROI by reducing costs, increasing gains, or accelerating gains.

ValueScope's approach to ROI analysis has been applied to asset purchase decisions, "go/no-go" decisions for programs of all kinds, and to more traditional investment decisions such as the use of capital.

The ROI analysis is performed by first collecting information from the organization about the "As Is" financial state, challenges and opportunities, as specified from personalized information provided and predicted over the next several years. The "As Is" scenario is often called the "do nothing" state whereby the proposed project is not yet implemented. Simulated against the "As Is" state is the proposed project and related best practices. The project investment is tallied and specific and personalized benefits applied, to simulate the "To Be" costs and benefits. The difference between "As Is' and "To Be" scenarios is the net cash flow from the proposed project, and is the focus of this analysis.

To create an ROI analysis, the As Is costs and opportunities are modeled first. Against the As Is plan, the To Be scenario is modeled, simulating the change costs to implement the project, and the proposed IT cost reductions, business operating expense savings and strategic business impact (incremental revenue and profit).

ROI analysis considers all of the costs of purchasing and owning an asset throughout its useful life-cycle.

The life-cycle costs typically include direct "hard" costs such as procurement labor, amortized capital investment in hardware and software, implementation and deployment labor and services, training, support and maintenance contracts, ongoing IT operations and administration, and facilities. As well, ROI models usually assess indirect "soft" costs of ownership such as the impact of downtime from security breaches and unplanned outages. Typically, the analysis is conducted over a three or five year analysis period, the typical useful life of the asset.

Financial Analysis

In the ROI analysis, the project's costs and benefits are compared over a five year analysis period using traditional risk-adjusted discounted cash flow analysis. The resultant cash flow is assessed and summarized using several financial calculations, which are essential for assessing project viability and selecting the most rewarding investments:

ROI is the ratio of the net gain from a proposed project, divided by its total costs. In a formula , this can be represented as:

ROI = cumulative net benefits / total costs

When calculated , ROI is represented as a percentage demonstrating the value of the investment and so in formula's ROI% will represent this value. As an example of how the ROI formula can be used to evaluate a solution, if a project has an ROI of 200%, the total net benefits derived from the project are double those of the expected total costs to implement the project. This means the ROI calculation represents the relative value of the project's cumulative net benefits over the analysis period, divided by the project's cumulative costs, expressed as a percentage.

Risk Adjusted ROI

Risk Adjusted ROI is the ratio of the net gain from a proposed project, divided by its total costs - represented in net present value terms to account for project risk. In a formula, this can be represented as:

Risk Adjusted ROI = Net Present Value of Cumulative Net Benefit / Net Present Value of Total Costs

When calculated, ROI is represented as a percentage demonstrating the value of the investment and so in formula's ROI% will represent this value. Each of the benefits and costs is adjusted into net present value terms to account for lack of visibility in future cash flows. It is important to remember that the ROI calculation in this solution is adjusted for risk by using the discount rate and net present value terms.

Internal Rate of Return (IRR)

IRR calculates the interest rate received for an investment consisting of costs and income that occur over the analysis period. By analyzing the costs, and when they occur, compared to the benefits over time, the IRR calculation estimates the return from the project as an interest rate calculation.
The IRR calculation is used to derive the value of the return in the NPV formula, whereby given a series of net benefits (I), the equation yields zero as the NPV. The calculation is performed iteratively, where a computer program guesses at the value of the return, and then continuously refines itself, until the equation yields a result at or near zero.

Risk (What-if Analysis)

Risks which are not mitigated can often lead to an increase in project costs and a decrease in benefit realization. As a result, the impact of risks should be modeled to create a conservative business case. To this end, the methodology provides tools to help assess the impacts of various risks, particularly on benefits. These can be set for the overall project or in most instances on a benefit by benefit basis and include:

• Accelerating or delaying planned deployments according to fiscal or calendar year timing
• Discounts for direct and indirect benefits
• Modeling of the delays in deploying the solution or feature and the beginning of benefit realization
• Modeling of delays in solution adoption