Appendix E---Cost-Benefit Analysis

Purpose

Current laws and regulations require agencies to conduct a cost/benefit
analysis (CBA) prior to deciding whether to initiate, continue, or
implement an IT investment. The level of detail required varies and
should be commensurate with the size, complexity, and cost of the
proposed investment. This appendix provides a layout of a CBA for a very
large, complex, and costly IT investment. A scaled down version is
appropriate for a smaller, less costly investment.

The CBA supports decision‑making and helps ensure resources are
effectively allocated to support mission requirements. The CBA should
demonstrate that at least three alternatives (excluding the option of
continuing current operations) were considered and the chosen
alternative is the most cost-effective, within the context of budgetary
and political considerations. Possible alternatives include:

-   In-house development versus contractor development,

-   In-house operation versus contractor operation,

-   Current operational procedures versus new operational procedures, or

-   One technical approach versus another technical approach.

The CBA should include comprehensive estimates of the projected benefits
and costs for each alternative. Costs, tangible benefits, and intangible
benefits (benefits which cannot be valued in dollars) should be
included. Intangible benefits should be evaluated and assigned relative
numeric values for comparison purposes. Sunk costs (costs incurred in
the past) and realized benefits (savings or efficiencies already
achieved) should not be considered since past experience is relevant
only in helping estimate future benefits and costs. Investments should
be initiated or continued only if the projected benefits exceed the
projected costs.

A CBA should be performed for each investment alternative to enable the
evaluation and comparison of alternatives. However, some mandatory
systems will not provide net benefits to the government. In such cases,
the lowest cost alternative should be selected. If functions are to be
added to a mandatory system, though, the additional functions should
provide benefits to the government.

Process

A CBA should be completed or updated at the following lifecycle
milestones:

-   Proposal initiation (Pre-Select Phase)

-   E-Board proposal consideration (Select Phase)

-   E-Board initiative review (annually during the Control Phase)

-   Initial fielding (Evaluation Phase)

-   Post-Implementation Review (Evaluation Phase)

-   Operations and Maintenance review (Steady-State Phase)

-   Annually for "major system" CPIC review.

The Project Sponsor ensures the CBA is done. The Project Sponsor can
obtain expertise from the IPT in systems development and operation,
budget, finance, statistics, procurement, architecture, and work
processes, as needed.

The CBA process can be broken down into the following steps:

1.  Determine/define objectives

2.  Document current process

3.  Estimate future requirements

4.  Collect cost data for alternatives

5.  Choose at least three alternatives

6.  Document CBA assumptions

7.  Estimate costs

8.  Estimate benefits

9.  Discount costs and benefits

10. Evaluate alternatives

11. Perform sensitivity analysis

12. Compare investments.

Each of these steps is detailed in the following sections. The numerical
examples provided are from a variety of sources and do not relate to one
specific investment.

1\. Determine/Define Objectives

The CBA should include a problem definition; pertinent background
information such as staffing, system history, and customer satisfaction
data; and a list of investment objectives that identify how the system
will improve the work process and support the mission.

2\. Document Current Process

The current process should be thoroughly documented and address these
areas:

-   Customer Service---Each customer's role and services required should
    be clearly documented and quantified, if possible (e.g., in an
    average month, a customer inputs two megabytes (MB) of data and
    spends 10 hours on database maintenance).

-   System Capabilities---Resources required for peak demand should be
    listed. For example, 100 MBs of disk storage space and Help Desk
    personnel to support 50 users.

-   System Architecture---The hardware, software, and physical
    facilities required should be documented, including information
    necessary for determining system costs, expected future utility of
    items, and the item owner/lessor (i.e., government or contractor).
    Table E-1---displays the information desired.

-   System Costs---Current costs provide the CBA baseline. Figure
    E-2---Cost Elements for Systems addresses the cost elements for most
    systems. However, a particular system may not include all elements
    identified within a category and may include some activities not
    shown.

**Table E-1. System Architecture Information Requirements**

+----------------------------+--------------------+--------------------+
| Hardware                   | Software           | Physical           |
|                            |                    | Facilities         |
+----------------------------+--------------------+--------------------+
| [Manufacturer]{.underline} | [Manufac           | [Loc               |
|                            | turer]{.underline} | ation]{.underline} |
| [Ma                        |                    |                    |
| ke/Model/Year]{.underline} | [Name]{.underline} | [Size]{.underline} |
|                            |                    |                    |
| [Cost]{.underline}         | [Version           | [Cap               |
|                            | n                  | acity]{.underline} |
| [Power                     | umber]{.underline} |                    |
| requirements]{.underline}  |                    | [Structure         |
|                            | [Year              | type]{.underline}  |
| [Expected                  | acq                |                    |
| life]{.underline}          | uired]{.underline} | [Availab           |
|                            |                    | ility]{.underline} |
| [Maintenance               | [License           |                    |
| requirements]{.underline}  | term]{.underline}  | [Annual            |
|                            |                    | cost]{.underline}  |
| [Operating characteristics | [Hardware          |                    |
| (e.g., size, speed,        | require            |                    |
| capacity,                  | ments]{.underline} |                    |
| etc.)]{.underline}         |                    |                    |
|                            | [Cost (annual or   |                    |
| [Operating systems         | purc               |                    |
| supported]{.underline}     | hase)]{.underline} |                    |
+----------------------------+--------------------+--------------------+

**Table E-2. Cost Elements for Systems**

  --------------------------------------------------------------------------
  Cost Category        Cost Elements
  -------------------- -----------------------------------------------------
  Equipment,\          Supercomputers, mainframes, minicomputers,
  Leased or Purchased  microcomputers, disk drives, tape drives, printers,
                       telecommunications, voice and data networks,
                       terminals, modems, data encryption devices, and
                       facsimile equipment.

  Software,\           Operating systems, utility programs, diagnostic
  Leased or Purchased  programs, application programs, and
                       commercial-off-the-shelf (COTS) software.

  Commercial Services  Commercially-provided services, such as
                       teleprocessing, local batch processing, on-line
                       processing, Internet access, electronic mail, voice
                       mail, centrex, cellular telephone, facsimile, and
                       packet switching.

  Support services\    Commercially-provided services to support equipment,
  (Contractor          software, or services, such as maintenance, source
  Personnel)           data entry, training, planning, studies, facilities
                       management, software development, system analysis and
                       design, computer performance evaluation, and capacity
                       management.

  Supplies             Any consumable item designed specifically for use
                       with equipment, software, services, or support
                       services identified above.

  Personnel            Includes the salary (compensation) and benefits for
  (compensation and    government personnel who perform IT functions
  benefits)            51percent or more of their time. Functions include
                       but are not limited to program management, policy, IT
                       management, systems development, operations,
                       telecommunications, computer security, contracting,
                       and secretarial support. Personnel who simply use IT
                       assets incidental to the performance of their primary
                       functions are not included.

  Intra-governmental   All IT services within agencies, and between
  services             executive branch agencies, judicial and legislative
                       branches, and State and local governments.
  --------------------------------------------------------------------------

3\. Estimate Future Requirements

Future customer requirements determine the system capabilities and
architecture, and ultimately affect system costs and benefits. Two items
to consider are:

-   Lifecycle Time---Determine the system lifecycle, or when the system
    is terminated and replaced by a system with significant changes in
    processing, operational capabilities, resource requirements, or
    system outputs. Large, complex systems should have a lifecycle of at
    least five years, and no more than ten to 12 years.

-   Lifecycle Demands---Identify the most appropriate demand measures
    and use the measures to determine previous year' demands, calculate
    the change in demand from year to year, average the demand change,
    and use the average to make predictions. In a complex situation,
    more sophisticated tools, such as time-series and regression
    analysis, may be needed to forecast the future.

4\. Collect Cost Data

Data can be collected, from the following sources, to estimate the costs
of each investment alternative:

-   Historical Organization Data---If contracts were used to provide
    system support in the past, they can provide the estimated future
    cost of leasing and purchasing hardware and hourly rates for
    contractor personnel. Contracts for other system support services
    can provide comparable cost data for the development and operation
    of a new system.

-   Current System Costs---Current system costs can be used to price
    similar alternatives.

-   Market Research---Quotes from multiple sources, such as vendors,
    Gartner Group, IDC Government, and government-wide agency contracts
    (GWACS), can provide an average, realistic price.

-   Publications---Trade journals usually conduct annual surveys that
    provide general cost data for IT personnel. Government cost sources
    include the General Services Administration (GSA) pricing schedule
    and the OMB Circular A‑76, "Performance of Commercial Activities"
    supplemental listing of inflation and tax rates.

-   Analyst Judgment---If data is not available to provide an adequate
    cost estimate, the CBA team members can use judgment and experience
    to estimate costs. To provide a check against the estimates, discuss
    estimated costs with other IT professionals.

-   Special Studies---Special studies can be conducted to collect cost
    data for large IT investments. For example, the Federal Aviation
    Administration (FAA) used three different in-house studies to
    provide costs for software conversion, internal operations, and
    potential benefits. These data sources became the foundation for a
    CBA.

5\. Choose at Least Three Alternatives

A CBA should present at least three viable alternatives. "Do nothing" or
"Continue current operations" should not be considered as an
alternative. Each viable technical approach should be included as an
alternative. However, the number of technical approaches may be limited
if only one or two are compatible with the architecture or if some
approaches are not feasible for reasons other than costs and benefits.

6\. Document CBA Assumptions

It is important to document all assumptions and, if possible, justify
them on the basis of prior experiences or actual data. This can be an
opportunity to explain why some alternatives are not included. If an
alternative is eliminated because it is not feasible, the assumption
should be clearly explained and justified.

7\. Estimate Costs

Many factors should be considered during the process of estimating costs
for alternatives. Full lifecycle costs for each competing alternative
should be included, and the following factors should be addressed:

-   Activities and Resources---Identify and estimate the costs
    associated with the initiation, design, development, operation, and
    maintenance of the IT system.

-   Cost Categories---Identify costs in a way that relates to the budget
    and accounting processes. The cost categories should follow current
    USDA object class codes.

-   Personnel Costs---Personnel costs are based on the guidance in OMB
    Circular A‑76, "Supplemental Handbook, PART II---Preparing the Cost
    Comparison Estimates." Government personnel costs include current
    salary by location and grade, fringe benefit factors, indirect or
    overhead costs, and General and Administrative costs.

-   Depreciation---The cost of each tangible capital asset should be
    spread over the asset's useful life (i.e., the number of years it
    will function as designed). OMB prefers that straight‑line
    depreciation be used for capital assets.

-   Annual Costs---All cost elements should be identified and estimated
    for each year of the system lifecycle. This is necessary for
    planning and budget considerations Table E-3**---**illustrates the
    cost estimates for an investment initiation activity.

**Table E-3. Sample Cost Estimates for an Investment Initiation
Activity**

+-----------------+------+------+------+------+------+------+------+
| >               | >    | >    | > R  | >    | >    | > C  | > T  |
| Activties/Cost\ | Prob | Work | equi | Secu | Perf | ost- | otal |
| > Categories    | lem\ | >    | reme | rity | orma | Bene |      |
|                 | > De |  Pro | nts\ | >    | nce\ | fit\ |      |
|                 | fini | cess | > De | Plan | >    | >    |      |
|                 | tion | > Ev | fini |      | Meas | Anal |      |
|                 |      | alua | tion |      | ures | ysis |      |
|                 |      | tion |      |      |      |      |      |
+-----------------+------+------+------+------+------+------+------+
| Hardware        |      |      |      |      |      |      |      |
+-----------------+------+------+------+------+------+------+------+
| Software        |      |      |      |      |      |      |      |
+-----------------+------+------+------+------+------+------+------+
| Services        |      |      |      |      |      |      |      |
+-----------------+------+------+------+------+------+------+------+
| Support         |      | 10   | 4    | 1    | 6    | 3    | 24   |
| Services        |      | ,000 | ,000 | ,000 | ,000 | ,000 | ,000 |
+-----------------+------+------+------+------+------+------+------+
| Supplies        |      | 100  | 100  | 0    | 100  | 100  | 400  |
+-----------------+------+------+------+------+------+------+------+
| Personnel       | 5    | 10   | 6    | 500  | 5    | 8    | 34   |
|                 | ,000 | ,000 | ,000 |      | ,000 | ,000 | ,500 |
+-----------------+------+------+------+------+------+------+------+
| Inter‑Agency    |      |      |      |      |      |      |      |
| Services        |      |      |      |      |      |      |      |
+-----------------+------+------+------+------+------+------+------+
| Total           | 5    | 20   | 10   | 1    | 11   | 11   | 58   |
|                 | ,000 | ,100 | ,100 | ,500 | ,100 | ,100 | ,900 |
+-----------------+------+------+------+------+------+------+------+

The costs for each year can be added to provide the estimated annual
costs over the investment's life. For example, Table E-4---Sample System
Lifecycle Cost Estimates provides the total estimated costs for a
10-year investment. In the first year, in-house staff and contractors
define the problem, evaluate the work process, define processing
requirements, prepare the CBA, develop a request for proposals (RFP),
and issue a contract for the system development. In the second year, a
contractor designs and implements the system. The next eight years
reflect operational and maintenance costs for equipment, software,
in-house personnel, and contractor personnel. Years five and six also
reflect in-house acquisition costs for establishing a new five-year
contract for system maintenance and help desk support.

**Table E-4. Sample System Lifecycle Cost Estimates**

  ------- --------- ------------- ------------- ----------- ------------- -----------
  Year    Startup   Acquisition   Development   Operation   Maintenance   Total

  1       100,000   100,000                                               200,000

  2                               800,000                                 800,000

  3                                             200,000     80,000        280,000

  4                                             200,000     60,000        260,000

  5                 50,000                      200,000     50,000        300,000

  6                 50,000                      200,000     50,000        300,000

  7                                             200,000     40,000        240,000

  8                                             200,000     30,000        230,000

  9                                             200,000     30,000        230,000

  10                                            200,000     30,000        230,000

  Total   100,000   200,000       800,000       1,600,000   370,000       3,070,000
  ------- --------- ------------- ------------- ----------- ------------- -----------

8\. Estimate Benefits

The following six activities are completed to identify and estimate the
value of benefits:

**Define Benefits**---Benefits are the services, capabilities, and
qualities of each alternative, and can be viewed as the return from an
investment. The following questions will help define benefits for IT
systems and enable alternative comparisons:

-   *Accuracy*---Will the system improve accuracy by reducing data entry
    errors?

-   *Availability*---How long will it take to develop and implement the
    system?

-   *Compatibility*---How compatible is the proposed alternative with
    existing procedures?

-   *Efficiency*---Will one alternative provide faster or more accurate
    processing?

-   *Maintainability*---Will one alternative have lower maintenance
    costs?

-   *Modularity*---Will one alternative have more modular software
    components?

-   *Reliability*---Does one alternative provide greater hardware or
    software reliability?

-   *Security*---Does one alternative provide better security to prevent
    fraud, waste, or abuse?

**Identify Benefits**---Every proposed IT system should have
identifiable benefits for both the organization and its customers.
Organizational benefits could include flexibility, organizational
strategy, risk management and control, organizational changes, and
staffing impacts. Customer benefits could include improvements to the
current IT services and the addition of new services. Customers should
help identify and determine how to measure and evaluate the benefits.

**Establish Measurement Criteria**---Establishing measurement criteria
for benefits is crucial because the Government Performance and Results
Act (GPRA) and the Clinger-Cohen Act (CCA) emphasize tangible measures
of success (benefits) related to the organization's overall mission and
goals. See Appendix G---Performance Measurement for guidance on how to
develop performance measures.

**Classify Benefits**---Benefits that are "capable of being appraised at
an actual or approximate value" are called tangible benefits. Benefits
that cannot be assigned a dollar value are called intangible benefits.

**Estimate Tangible Benefits**---The dollar value of benefits can be
estimated by determining the fair market value of the benefits. An
important economic principle used in estimating public benefits is the
market value concept. Market value is the price that a private sector
organization would pay to purchase a product or service

**Quantify Intangible Benefits**---Intangible benefits can be quantified
using a subjective, qualitative rating system. A qualitative rating
system might evaluate potential benefits against the following:

-   Provides Maximum Benefits (2 points)

-   Provides Some Benefits (1 point)

-   Provides No Benefits (0 points)

-   Provides Some Negative Benefits\
    (-1 point)

-   Provides Maximum Negative Benefits\
    (-2 points).

Once the rating system is selected, each benefit is evaluated for each
alternative. This should be done by a group of three to five individuals
familiar with the current IT system and the alternatives being
evaluated. The numerical values assigned to the ratings then can be
summed and averaged to obtain a score for each benefit. Table
E-5**---**shows the scores for benefits A to D from four reviewers using
a scale of 1 to 5.

**Table E-5. Sample Reviewer Scores for Intangible Benefits**

  --------- ----------- ------------ ------------ ----------- ---------------
  Benefit   Reviewer 1\ Reviewer 2\  Reviewer 3\  Reviewer 4\ Reviewer\
            Score       Score        Score        Score       Average Score

  A         5           4            3            5           4.25

  B         4           2            3            4           3.25

  C         3           2            5            4           3.50

  D         4           3            2            2           2.75
  --------- ----------- ------------ ------------ ----------- ---------------

An option that can be used in a qualitative assessment is to "weight"
each benefit criteria with regard to importance. The more important the
benefit, the higher the weight. The advantage of weighting is the more
important benefits have a greater influence on the benefit analysis
outcome. The weighting scale can vary between any two predetermined high
and low weights. An example of calculating a weighted score is provided
in Table E-6**---**and demonstrates using weighting factors makes
Alternative 1 the clear winner.

9\. Discount Costs and Benefits

After costs and benefits for each system lifecycle year have been
identified, convert them to a common measurement unit by discounting
future dollar values and transforming future benefits and costs to their
"present value." Present values are calculated by multiplying the future
value times the discount factors published in the OMB Circular A‑94.

**Table E-6. Sample Weighted Benefits Score**

  --------- ------------- ------------- ------------ -------------- --------------
  Benefit   Alternative 1 Alternative 2 Weighting\   Alternative 1  Alternative 2
            Raw Score     Raw Score     Factor       Weighted Score Weighted Score

  A         4             2             10           40             20

  B         3             2             9            27             18

  C         4             3             8            32             24

  D         2             3             6            12             18

  E         3             4             5            15             20

  Total     16            14                         126            100
  --------- ------------- ------------- ------------ -------------- --------------

Table E-7**---**shows annual costs and benefits for a system lifecycle,
along with the discount factor, the discounted costs and benefits
(present values), and the discounted net present value \[NPV\]. The
discounted costs and benefits are computed by multiplying costs and
benefits by the discount factor. The net benefit without discounting is
\$380,000 (\$3,200,000 minus \$2,820,000) while the discounted NPV is
less than \$60,000 because the biggest costs are incurred in the first
two years, while the benefits are not accrued until the third year. When
evaluating costs and benefits, be cautious of returns that accrue late
in the investment's lifecycle. Due to discounting, benefits that accrue
in later years do not offset costs as much as earlier-year benefits.
Also, these later-year benefits are less certain. Both the business and
IT environments may experience significant changes before these
later-year benefits are realized.

**Table E-7. Sample Discounted Lifecycle Costs and Benefits**

  ------- ----------- ----------- ---------- ------------- ------------- -------------
  Year    Annual      Annual      Discount   Discounted\   Discounted\   Discounted\
          Cost\       Benefit     Factor     Cost (DC)\    Benefit (DB)\ Net\
          (AC)        (AB)        (DF)       ACxDF         ABxDF         DB - DC

  1       150,000                 0.9667     145,005                     (145,005)

  2       600,000                 0.9035     542,100                     (542,100)

  3       280,000     400,000     0.8444     236,432       337,760       101,328

  4       260,000     400,000     0.7891     205,166       315,640       110,474

  5       300,000     400,000     0.7375     221,250       295,000       73,750

  6       300,000     400,000     0.6893     206,790       275,720       68,930

  7       240,000     400,000     0.6442     154,608       257,680       103,072

  8       230,000     400,000     0.6020     138,460       240,800       102,340

  9       230,000     400,000     0.5626     129,398       225,040       95,642

  10      230,000     400,000     0.5258     120,934       210,320       89,386

  Total   2,820,000   3,200,000              2,100,143     2,157,960     57,817
  ------- ----------- ----------- ---------- ------------- ------------- -------------

10\. Evaluate Alternatives

Many benefits cannot be quantified in dollar terms. As a result,
evaluating alternatives cannot always be done using present values, but
valid evaluations can be made using a combination of dollar values and
quantified relative values (values that are numeric, but do not
represent dollar values).

**Evaluate All Dollar Values**---Once all the costs and benefits for
each competing alternative have been assigned dollar values and
discounted, the NPV of the alternatives should be compared and ranked.
When the alternative with the lowest discounted cost provides the
highest discounted benefit, it is the clear winner, as shown in Table
E-8.

**Table E-8. Sample Investment Comparison**

(Lowest Cost System Provides Highest Benefit)

  ------------- ------------ -------------- --------------- ---------------
  Alternative   Discounted   Discounted     Discounted Net  Benefit-Cost
                Cost (DC)    Benefit (DB)   (DB - DC)       Ratio (DB/DC)

  1             1,800,000    2,200,000      400,000         1.22

  2             1,850,000    1,750,000      (-100,000)      0.95

  3             2,000,000    2,000,000      0               1.00

  4             2,200,000    2,100,000      (-100,000)      0.95
  ------------- ------------ -------------- --------------- ---------------

**Discounted Net**---There will probably be very few cases where the
alternative with the lowest discounted cost provides the highest
discounted benefit. The next number to consider is the Discounted Net
(Discounted Benefit minus Discounted Cost). If one alternative clearly
has the highest Discounted Net, it is considered the best alternative;
however, it is usually advisable to look at other factors*.*

**Benefit-Cost Ratio**---When the alternative with the highest
discounted net is not a clear winner, the benefit-cost ratio or BCR
(discounted benefit divided by discounted cost) may be used to
differentiate between alternatives with very similar or equal Discounted
Nets. In Table E-9--- Alternative 4 would be the winner because it has a
higher BCR than Alternative 5. Alternatives 4 and 5 are clearly superior
to other alternatives because they have the highest discounted net.

**Evaluate With Intangible Benefits**---When all the benefits are
intangible, evaluation will be based on quantifying relative benefits.

**Table E-9. Sample Investment Comparison**

(Other Than Lowest Cost System Provides Highest Benefit)

  ------------- ------------- -------------- -------------- ---------------
  Alternative   Discounted    Discounted     Discounted Net Benefit-Cost
                Cost (DC)     Benefit (DB)   (DB‑DC)        Ratio (DB/DC)

  1             1,500,000     1,600,000      100,000        1.07

  2             1,600,000     1,750,000      150,000        1.09

  3             1,900,000     2,000,000      100,000        1.05

  4             2,000,000     2,450,000      450,000        1.23

  5             3,000,000     3,450,000      450,000        1.15
  ------------- ------------- -------------- -------------- ---------------

11\. Perform Sensitivity Analysis

Sensitivity analysis tests the sensitivity of input parameters and the
reliability of the CBA result. Sensitivity analysis should assure
reviewers the CBA provides a sound basis for decisions. The sensitivity
analysis process requires the following:

**Identify Input Parameters**---The assumptions documented earlier in
the CBA are used to identify the model inputs to test for sensitivity.
Good inputs to test are those that have significant (large) cost factors
and a wide range of maximum and minimum estimated values. Some common
parameters include:

-   System requirement definition costs

-   System development costs

-   System operation costs

-   Transition costs, especially software conversion

-   System lifecycle

-   Peak system demands.

**Repeat the Cost Analysis**---For each parameter identified, determine
the minimum and maximum values. Then, choose either the minimum or
maximum value as the new parameter value (the number selected should be
the one that most differs from the value used in the original analysis).
Repeat the CBA with the new parameter value and document the results.
Prepare a table like Table E-10**---**to summarize the different
outcomes and enable the results to be quickly evaluated.

**TableE-10. Sample Sensitivity Analysis**

  ----------------------------- --------------------- --------------------
  Parameter                     Parameter\            Best\
                                Value                 Alternative

  Development\                  1,500,000\            A\
  Cost (\$)                     2,000,000\            A\
                                2,500,000             B

  Transition Costs (\$)         100,000\              A\
                                200,000               A

  System\                       5\                    A\
  Lifecycle (Years)             10\                   B\
                                15                    C

  Benefits (\$)                 1,500,000\            A\
                                2,250,000\            A\
                                3,000,000             B
  ----------------------------- --------------------- --------------------

**Evaluate Results**---Compare the original set of inputs and the
resulting outcomes to the outcomes obtained by varying the input
parameters. In the previous table, the original values are the first
value listed for each parameter. Sensitivity is measured by how much
change in a parameter is required to change the alternative selected in
the original analysis. The sensitivity guidelines include the following:

-   A parameter is not considered sensitive if it requires a decrease of
    50 percent or an increase of 100 percent to cause a change in the
    selected alternative.

-   A parameter is considered sensitive if a change between 10 and 50
    percent causes a change in the selected alternative.

-   A parameter is considered very sensitive if a change of 10 percent
    or less causes a change in the selected alternative.

In the previous example, the analysis would appear to be somewhat
sensitive to the development costs, but not sensitive to the transition
costs and benefits.

12\. Compare Investments

Even if the CBA shows that benefits will outweigh costs, using Payback
Period and Return on Investment (ROI) analysis help demonstrate an
investment is a better utilization of funds than other proposed
investments.

Table E-11**---**illustrates that the money invested in the system's
development, installation, and operation is not offset by the benefits
until the 10th year. In other words, the payback period for the system
is 10 years, which is generally unacceptable, making it difficult for
this investment to obtain funding.

**Table E-11. Sample Payback Period**

  ------- ----------- ----------- ----------- ------------- ------------- ------------- -------------
  Year    Annual\     Annual\     Discount\   Discounted\   Discounted\   Discounted\   Cumulative\
          Cost\       Benefit\    Factor\     Cost (DC)\    Benefit (DB)\ Net\          Discounted
          (AC)        (AB)        (DF)        ACxDF         ABxDF         DB - DC       Net

  1       150,000                 0.9667      145,010       0             (145,010)     (145,010)

  2       600,000                 0.9035      542,095       0             (542,095)     (687,106)

  3       280,000     400,000     0.8444      236,428       337,754       101,326       (585,779)

  4       260,000     400,000     0.7891      205,178       315,658       110,480       (475,299)

  5       300,000     400,000     0.7375      221,256       295,007       73,751        (401,547)

  6       300,000     400,000     0.6893      206,781       275,708       68,927        (332,620)

  7       240,000     400,000     0.6442      154,603       257,671       103,068       (229,552)

  8       230,000     400,000     0.6020      138,468       240,814       102,346       (127,206)

  9       230,000     400,000     0.5626      129,409       225,060       95,651        (31,556)

  10      230,000     400,000     0.5258      120,943       210,336       89,393        57,837

  Total   2,820,000   3,200,000               2,100,171     2,158,008     57,837        
  ------- ----------- ----------- ----------- ------------- ------------- ------------- -------------

**Return on Investment**---ROI is often used when comparing proposed
investments. Total Discounted Net (Total Discounted Benefits minus the
Total Discounted Costs) is often referred to as the return or profit
from an investment. ROI is calculated by dividing the Total Discounted
Net by the Total Discounted Cost. In the figure above, ROI is the Total
Discounted Net (\$57,837) divided by Total Discounted Costs
(\$2,100,171) and equals 0.0275. Since ROI is often cited as a
percentage, multiplying by 100 converts the decimal rate to 2.75.

The ROI is really just another way to express the BCR. In the example
above, the BCR is the Total Discounted Benefit (\$2,158,008) divided by
the Total Discounted Costs (\$2,100,171) and equals 1.0275. The 1.0275
can also be expressed as 102.75 percent. This means that the benefits
are 2.75 percent greater than the costs. Compute the ROI by subtracting
1 from the BCR.

The ROI must also be adjusted for risk. To adjust ROI for risk, use the
process described for calculating the risk factor described in
Appendix F.2. The "risk factor" for all risks should be totaled and
added to the investment cost. Adjusting the ROI for risk will aid in
comparing alternatives with different potential risk levels and will
help ensure that returns for investments with higher risk potential are
fully understood. (See Appendix F---Risk Assessment for a more detailed
discussion on risk analysis.)