Chapter 14

Evaluating AIS Investments

True / False Questions

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

14-1
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
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 on new technology is an example of direct operating
costs.

True False

Multiple Choice Questions

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

14-2
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 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

14-3
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
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.

14-4
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 support

B. Conduct training and provide incentives
C. Use the balanced scorecard framework
D. Use sensitivity analysis

Essay Questions

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?

14-5
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

Required: 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

Required: 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.

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%.

Required: 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

True / False Questions

1. In making the business case for an IT investment, companies should assess the sensitivity of
results to the assumptions.

TRUE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

2. The appropriate cost of capital to use in valuing an IT project is the same regardless of the
project riskiness.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

3. Capital budgeting techniques provide precise estimates on an IT projects costs and benefits.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology

14-9
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
 Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

4. Net present value techniques compute the unique rate of return for a particular IT project.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

5. One weakness of the internal rate of return financial metric is that larger projects tend to have
higher internal rates of return.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-06 Apply capital budgeting techniques to assess the value of an IT initiative.
Source: Original
Topic: Evaluating AIS Investments

6. The value proposition step in the analysis of an IT initiative should focus on five questions,
including the timing of expected benefits.

TRUE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
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: Original
Topic: Evaluating AIS Investments

7. The benefits of an IT project are not necessarily measurable in financial terms.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

8. Benefits are often estimated without complete information.

TRUE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

9. The business case for an IT project does not need to address risk, since risk will be factored into
the discount rate.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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.

FALSE

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-04 Assess potential costs of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

Multiple Choice Questions

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

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

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 does it address?

B. What are the risks of doing the project?
C. How will success be measured?
D. None of the above

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-01 Articulate similarities and differences between major IT initiatives and other capital investments.
Source: Original
Topic: Evaluating AIS Investments

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

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-02 Explain the major steps in the economic justification of an IT initiative.
Source: Original
Topic: Evaluating AIS Investments

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 IT initiative?

A. Cost of hardware
B. Cost of business disruption
C. Cost of project management
D. Cost of software development

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

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

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

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
B. Revenue savings
C. Cost avoidance
D. Revenue protection

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

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

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-03 Explain potential benefits of IT initiatives and how to evaluate them.
Source: Original
Topic: Evaluating AIS Investments

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 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.

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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.

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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 support

B. Conduct training and provide incentives
C. Use the balanced scorecard framework
D. Use sensitivity analysis

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

Essay Questions

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?

Open ended.

AACSB: Analytic
AICPA BB: Leveraging Technology
AICPA FN: Leveraging Technology
Blooms: Evaluate
Difficulty: 3 Hard
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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

Required: 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 Technology
AICPA FN: Leveraging Technology
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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?

(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 Technology
AICPA FN: Leveraging Technology
Blooms: Evaluate
Difficulty: 3 Hard
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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

Required: 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 Technology
AICPA FN: Leveraging Technology
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

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%.

Required: 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 Technology
AICPA FN: Leveraging Technology
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 14-05 Describe potential risks of IT initiatives and corresponding risk mitigation techniques.
Source: Original
Topic: Evaluating AIS Investments

14-20
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.