Chapter 14 Evaluating AIS Investments
1.
In making the business case for an IT investment, companies should assess the sensitivity of results to the assumptions. True
False
2. The appropriate cost of capital to use in valuing an IT project is the same regardless of the project riskiness. True
False
3. Capital budgeting techniques provide precise estimates on an IT projects costs and benefits. True
False
4. Net present value techniques compute the unique rate of return for a particular IT project. True
False
5. One weakness of the internal rate of return financial metric is that larger projects tend to have higher internal rates of return. True
False
6. The value proposition step in the analysis of an IT initiative should focus on five questions, including the timing of expected benefits. True
False
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7. The benefits of an IT project are not necessarily measurable in financial terms. True
False
8. Benefits are often estimated without complete information. True
False
9. The business case for an IT project does not need to address risk, since risk will be factored into the discount rate. True
False
10. Time that employees devote to self-training self -training on new technology is an example of direct operating costs. True
False
11. Which of the following is not a reason that large IT projects require economic justification?
A. IT is a commodity, every firm makes IT investments B. IT investments require large amounts of capital C. Capital resources are limited D. Major IT projects can affect substantial portions of the organization
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12. Which of the following is not a question that businesses should answer before making major IT investments?
A. What key business issues does it address? B. What are the risks of doing the project? C. How will success be measured? D. None of the above 13. Which of the following is not a major consideration when assessing business requirements for IT initiatives?
A. Complementary business process changes B. Potential technological solutions C. Gaps in performance indicated by the strategy map D. Project risks 14. Which of the following is not a direct acquisition cost of an IT initiative?
A. Cost of hardware B. Cost of business disruption C. Cost of project management D. Cost of software development 15. Which of the following is not a direct operating cost of an IT initiative?
A. End-user data management B. Ongoing hardware replacement C. Software upgrades D. Hardware disposal
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16. Which of the following is not a potential benefit of an IT investment?
A. Revenue enhancement B. Revenue savings C. Cost avoidance D. Revenue protection 17. Which of the following is the least effective approach to quantifying expected benefits of an IT project?
A. Find out what other firms experienced in similar situations B. Review options with the hardware vendor C. Consult with experts D. Use simulation software 18. Which of the following is an example of project risk?
A. The technology will not work as expected. B. The IT project is not aligned with the company's strategy. C. The financial benefits may not be delivered. D. The IT project may exceed budget. 19. Which of the following is an example of solution risk?
A. The solution is not aligned with the company's strategy. B. The solution will not generate projected benefits. C. The solution will be delayed. D. Employees are unwilling to make the necessary changes.
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20. Which of the following is the best approach to mitigate alignment risk?
A. Assure top management support B. Conduct training and provide incentives C. Use the balanced scorecard framework D. Use sensitivity analysis
21. Explain why it is easier to assess the costs of an IT project than to assess the benefits. What factors complicate the cost estimates? What factors complicate the benefits estimates? Do the risks associated with the project primarily affect the costs or the benefits? Why?
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22. Pacific Green Company is considering buying a unique bar-coding machine to help them th em track their plant inventory. They are using the payback period and accounting rate of return methods to evaluate the purchase. They will consider the project further if the payback period is less than four years and it has a minimum accounting accounting rate of return of 7%. Relevant information on the machine is as follows: Acquisition cost = $48,000 Expected salvage value = $0 Expected annual cash inflow benefits = $13,000 per year for 5 years Expected useful life = 5 years : Compute the payback period and ARR. Advise GPC on their appropriate action.
23. Yellow Duck Brewery is considering two similar technology investments to help track production. Investment (1) has an NPV of $245,000 and a payback period of 3 years. Investment (2) has an NPV of $250,000 and a payback period of 4.25 years. Which investment would you advise them to choose? Why?
14-6 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
24. Pacific Green Company is considering buying a unique bar-coding machine to help them track their plant inventory. They evaluated the payback period and accounting rate of return and selected the project for further evaluation. Relevant information on the machine is repeated as follows: Acquisition cost = $48,000 Expected salvage value = $0 Expected annual cash inflow benefits = $13,000 per year for 5 years Expected useful life = 5 years : Compute the net p resent value of the project assuming a discount rate of 16%. Use EXCEL to compute the internal rate of return. Advise PGC on the best course of action with respect to the investment.
14-7 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
25. Cooper Automotive is considering expanding, but to do so, they need to invest in new systems expected to cost $1,000,000. They estimate the salvage value to be $0 at the end of 10 years, so depreciation will be $100,000 per year. They estimate that profits will increase by $250,000 per year. Coop's cost of capital is 10%. : Compute the payback period, the accounting rate of return, the net present value, and the internal rate of return. Advise Coop on whether he should invest. Would your advice change if the increase in profits is only $175,000 per year?
14-8 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 14 Evaluating AIS Investments Answer Key
1.
In making the business case for an IT investment, companies should assess the sensitivity of results to the assumptions.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
2.
The appropriate cost of capital to use in valuing an IT project is the same regardless of the project riskiness.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
3.
Capital budgeting techniques provide precise estimates on an IT projects costs and benefits.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog 14-9 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
4.
Net present value techniques compute compute the unique rate of return for a particular IT project.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Remembe Difficulty: 1 Eas Learning Objective: 14-01 Articulate similarities an d differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
5.
One weakness of the internal rate of return financial metric is that larger projects tend to have higher internal rates of return.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-06 Apply capital budgeting techniques to assess the value of an IT initiative. Source: Origina Topic: Evaluating AIS Investment
6.
The value proposition step in the analysis of an IT initiative should focus on five questions, including the timing of expected benefits.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium 14-10 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective: 14-02 Explain the major steps in the economic justification of an IT initiative. Source: Origina Topic: Evaluating AIS Investment
7.
The benefits of an IT project are not necessarily measurable measurable in f inancial terms.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
8.
Benefits are often estimated without complete information.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
9.
The business case for an IT project does not need to address risk, since risk will be factored into the discount rate.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
14-11 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
10.
Time that employees devote to self-training on new technology is an example of direct operating costs.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-04 Assess potential costs of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
11.
Which of the following is not a reason that large IT projects require economic justification? justification?
IT is a commodity, every firm makes IT investments B. IT investments investments require require large amounts of capital C. Capital resources are limited limited D. Major IT projects can affect substantial substantial portions of the organization organization AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-01 Articulate similarities an d differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
14-12 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
12.
Which of the following is not a question that businesses should answer before making major IT investments?
A. What key business issues issues does it address? B. What are the risks of doing the project? C. How will will success success be measured? None of the above AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments. Source: Origina Topic: Evaluating AIS Investment
13.
Which of the following is not a major consideration when assessing business requirements requirements for IT initiatives?
A. Complementary business process changes B. Potential technological solutions C. Gaps in performance indicated indicated by the strategy map Project risks AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-02 Explain the major steps in the economic justification of an IT initiative. Source: Origina Topic: Evaluating AIS Investment
14-13 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
14.
Which of the following is not a direct acquisition cost of an I T initiative?
A. Cost of hardware Cost of business disruption C. Cost of project project management D. Cost of software development AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Remembe Difficulty: 1 Eas Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
15.
Which of the following is not a direct operating cost of an IT initiative?
End-user data management B. Ongoing hardware replacement C. Software upgrades D. Hardware disposal AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Remembe Difficulty: 1 Eas Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
14-14 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
16.
Which of the following is not a potential benefit of an IT investment?
A. Revenue enhancement Revenue savings C. Cost avoidance D. Revenue protection AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
17.
Which of the following is the least effective approach to quantifying expected benefits of an IT project?
A. Find out what other firms experienced in similar similar situations situations Review options with the hardware vendor C. Consult with experts D. Use simulation software AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them. Source: Origina Topic: Evaluating AIS Investment
14-15 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
18.
Which of the following is an example of project risk?
A. The technology technology will not work as expected. B. The IT project is not aligned aligned with the company's strategy. strategy. C. The financial financial benefits benefits may not be delivered. The IT project may exceed budget. AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Remembe Difficulty: 1 Eas Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
19.
Which of the following is an example of solution risk?
A. The solution is not aligned aligned with the the company's strategy. strategy. The solution will not generate projected benefits. C. The solution solution will be delayed. D. Employees are unwilling unwilling to make make the necessary necessary changes. AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Remembe Difficulty: 1 Eas Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
14-16 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
20.
Which of the following is the best approach to mitigate alignment risk?
A. Assure top management management support B. Conduct training and provide incentives Use the balanced scorecard framework D. Use sensitivity analysis AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Understan Difficulty: 2 Medium Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
21.
Explain why it is easier to assess the costs of an IT project than to assess the benefits. What factors complicate the cost estimates? What factors complicate the benefits estimates? Do the risks associated with the project primarily affect the costs o r the benefits? Why?
Open ended.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Evaluate Difficulty: 3 Har Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
14-17 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
22.
Pacific Green Company is considering buying a unique bar-coding machine to help them track their plant inventory. They are using the payback period and accounting rate of return methods to evaluate the purchase. They will consider the project further if the payback period is less than four years and it has a minimum accounting rate of return of 7%. Relevant information on the machine is as follows: Acquisition cost = $48,000 Expected salvage value = $0 Expected annual cash inflow benefits = $13,000 per year for 5 years Expected useful life = 5 years : Compute the payback period and ARR. Advise GPC on their appropriate action.
Payback period = $48,000/$13,000 = 3.7 years ARR = ($13,000 - $9,600 depreciation expense)/$48,000 = 7.1% It meets the thresholds for further evaluation
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Appl Difficulty: 3 Har Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
23.
Yellow Duck Brewery is considering two similar technology investments investments to help track production. Investment (1) has an NPV of $245,000 and a payback period o f 3 years. Investment (2) has an NPV of $250,000 and a payback period of 4.25 years. Which investment would you advise them to choose? Why?
(open ended but they should address the decreased risk connected with the shorter payback period despite the slight difference in NPV).
AACSB: Analytic
14-18 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Evaluate Difficulty: 3 Har Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
24.
Pacific Green Company is considering buying a unique bar-coding machine to help them track their plant inventory. They evaluated the payback period and accounting rate of return and selected the project for further evaluation. Relevant information on the machine is repeated as follows: Acquisition cost = $48,000 Expected salvage value = $0 Expected annual cash inflow benefits = $13,000 per year for 5 years Expected useful life = 5 years : Compute the net present value of the project assuming a discount rate of 16%. Use EXCEL to compute the internal rate of return. Advise PGC on the best course of action with respect to the investment.
NPV is negative IRR is approximately 11% (and below GPC's hurdle rate) Do not invest
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Appl Difficulty: 3 Har Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
14-19 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
25.
Cooper Automotive is considering expanding, but to do so, they need to invest in new systems expected to cost $1,000,000. They estimate the salvage value to be $0 at the end of 10 years, so depreciation will be $100,000 per year. They estimate that profits will increase by $250,000 per year. Coop's cost of capital is 10%. : Compute the payback period, the accounting rate of return, the net present value, and the internal rate of return. Advise Coop on whether he should invest. Would your advice change if the increase in profits is only $175,000 per year?
At $250,000 annual incremental profit: Payback is 4 years; ARR is 15%; NPV is ~$500,000; IRR is 21%. Invest At $175,000 annual incremental profit: Payback increases to almost 6 years; ARR drops to 7.5%; NPV decreases to ~$75,000; IRR decreases to 12%. Advise evaluating the sensitivity of the estimates to changes in assumptions.
AACSB: Analytic AICPA BB: Leveraging Technolog AICPA FN: Leveraging Technolog Blooms: Appl Difficulty: 3 Har Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques. Source: Origina Topic: Evaluating AIS Investment
14-20 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
