Cost Benefit Analysis

GMAC RFC Confidential Internal Use Only Cost Benefit Analysis PROJECT INFORMATION Project Name: Project Manager: Business Reviewer: Document Preparer: Business Area Sponsor: Financial Category Initial Investment Project Start (Yr 0) Submitted Date: Estimated Start: Estimated Completion: Statement of Work: Project Type: Period 1 200x 12 Period 4 #VALUE! Period 2 #VALUE! Period 3 #VALUE! Period 5 #VALUE! Total Enter in cell D12 the # of months remaining in Period 1 (if other than 12) BENEFITS Direct Benefits: Total Direct Benefits $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ - Indirect Benefits: Total Indirect Benefits Total Direct & Indirect Benefits $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ - COSTS Capital Investment: Total Capital Investment $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ - Business Costs: Cost> Cost> Cost> Cost> Cost> $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ - IT Costs: Total IT Costs Total Costs $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ - NET CASH FLOW Net Cash Flow with Direct Benefits Net Cash Flow w/ Direct & Indirect Benefits $ $ $ $ $ $ $ $ $ $ $ $ $ $ - CASH FLOW ANALYSIS Discount Rate = 15.00% Net Present Value (NPV): NPV with Direct Benefits NPV with Direct & Indirect Benefits Internal Rate of Return (IRR): IRR with Direct Benefits IRR with Direct & Indirect Benefits #VALUE! #VALUE! #VALUE! IRR expects at least one positive cash flow and one negative cash flow #VALUE! IRR expects at least one positive cash flow and one negative cash flow Signature & Approval Prepared By: Reviewed By Finance Associate: Reviewed By Business Associate: 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls CBA Template Page 1 of 6 Printed: 8/12/2008 GMAC RFC Confidential Internal Use Only Cost Benefit Analysis: Assumptions Use this sheet to document assumptions. 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls Assumptions Page 2 of 6 Printed: 8/12/2008 GMAC RFC Confidential Internal Use Only Residential Capital Group STANDARDS FOR PREPARING A COST BENEFIT ANALYSIS Frequently Asked Questions What costs do I include in a Cost Benefit Analysis (CBA)? The costs in the CBA include those cash outflows that are directly associated with the project. Examples are as follows: Example 1 – A project requires a RCG IT System Analyst for 2 months. The Systems Analyst is a salaried associate and will be assigned specific project work. Since the person is directly associated with the project, the cost of this person should be included in the CBA. For many IT resources, there are standard Skill Set hourly rates that can be used to calculate labor costs. Refer to the attached Standard Labor Rate matrix for details. Example 2 - A project requires a $300,000 RCG capitalized asset purchase, and for accounting purposes, the asset will be depreciated over three years. This cost should be included on the CBA since it is directly related to the project. The full purchase price of $300,000 should be shown in the “initial investment column” as a cost at the beginning of the project, rather than shown as an expense over 3 years. As a result, the CBA will properly show the cash outflow of the project, rather than the accounting treatment. Example 3 – A project requires servers that will be provided by ETS. The additional server cost should be included in the CBA since it is directly related to the project. The amount to include in the CBA template is the on-going annual charge using the same amounts and timing that RCG will be charged by ETS. Note: The costs to be included in the CBA include both Business and IT costs. The Business and IT costs are entered in separate sections of the CBA template, so that these costs can be separately identified. What benefits are included in the CBA? Benefits that are created as a result of the project should be included in the CBA. In general, these benefits will be either incremental increases in revenue or incremental decreases in cost. The CBA template requires all benefits to be categorized as either, a) direct or b) indirect benefits. A key in determining the categorization of direct vs. indirect benefits is the ability to trace the specific benefit to financial results. A direct benefit is defined as one that affects the organization’s bottom line. This benefit will be seen in the accounts of the organization; it directly improves the financial performance of the organization. An indirect benefit is defined as one in which it is difficult to make a credible connection between what can be measured and the impact on corporate financial results. Indirect benefits are harder to quantify, however, indirect benefits do have value and should be quantified and shown in the CBA whenever possible. If a project is started mid-year, should benefits be shown by Year One, Year Two, etc. or shown by fiscal year? Enter the benefits on an annual basis by fiscal year (ex. 2006, 2007, 2008, etc.). 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls CBA Standards & Policies Page 3 of 6 Printed: 8/12/2008 GMAC RFC Confidential If a project is started mid-year, should benefits beInternal Use Only Year One, Year Two, etc. or shown by shown by fiscal year? Enter the benefits on an annual basis by fiscal year (ex. 2006, 2007, 2008, etc.). How do I quantify increased loan volume in a CBA? In certain cases, information exists for estimating detailed loan volume quantities by product and the applicable basis point spreads for those products. Therefore, that information should be used and shown in the detail assumptions. In situations where detailed information does not exist, quantify the benefits by determining the incremental funded loan volume times the basis point spread. This alternative is referred to as the Gross Value Add (GVA) methodology. The Residential Capital Group will use the GVA methodology as an interim solution until product level cash-flow assumptions are derived. Does the CBA reflect the cash-flow impact or P&L impact? The CBA template reflects the cash-flow impact of the project, as this is the proper methodology for computing Net Present Value. The P&L impact is not included in the CBA; however, this view can be added depending on business needs. How does a CBA reflect the tax impact of this project? For simplicity purposes, the CBA template shows costs and benefits before the impact of income taxes. How much detail should be provided in the CBA? Any assumptions and related details should be added in a separate worksheet(s) within the CBA template. Include as much detail as possible about the assumptions and the calculations that comprise the costs and benefits in the CBA template. As a guide, a resource unfamiliar with this project should be able to understand all the costs, benefits and project assumptions by reviewing one document. I have five inter-related projects that roll-up to one program. Should I prepare five individual CBAs or one CBA at the program level? An outcome of preparing CBAs is to capture all the benefits created from invested dollars. The desired outcome to consider is which method will better show the complete picture of benefits for decision-making purposes. If the individual projects have specifically identifiable benefits related to each of them, it is more likely that you would prepare five CBAs. If the benefits are primarily identifiable at the program level, then a single CBA is appropriate. When in the project lifecycle do I prepare a CBA? A CBA should be prepared as early as possible in the project lifecycle, and no later than the Statement of Work (SOW) phase. When preparing a CBA, how many years should I consider for estimating costs and benefits? The CBA measurement period should extend for the length of time that there are incremental cash inflows or outflows. For RCG, this will generally be 3 – 5 years. What discount rate should I use? The discount rate included in the Net Present Value (NPV) calculation is reviewed periodically. The current discount rate is 15%. For further guidance and the definition of the discount rate, see the detailed CBA instructions. Does anyone review the CBA for consistency of CBAs across RCG? All CBAs are reviewed by a RCG Finance Senior Finance Officer (SFO), or their designee, to determine compliance with CBA Standards & Policies as outlined in this document. The signature of a RCG SFO or their designee on a CBA signifies compliance with the “Standards for Preparing a Cost Benefit Analysis.” 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls CBA Standards & Policies Page 4 of 6 Printed: 8/12/2008 GMAC RFC Confidential Internal Use Only Cost Benefit Analysis: Helpful Tables IT Resource Standard Labor Rate Cost Per Hour Data as of July 2005 RCG IT Skill Sets Business Systems Analysis: Per Hour $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 94 104 115 83 90 112 122 86 99 107 123 136 79 98 109 78 89 102 118 131 90 105 124 150 84 87 99 Business Systems Analyst II Business Systems Analyst III Sr Business Systems Analyst Data Management: Data Analyst I Data Analyst II Sr Data Analyst Data Architect Project Management: Project Lead Project Manager I Project Manager II Sr Project Manager Program Manager Quality Assurance & Testing: Testing Analyst Il Sr Testing Analyst Sr QA Analyst Software Development: Software Developer I Software Developer II Software Developer III Sr Software Developer Software Development Architect Systems Engineering: Systems Engineer I Systems Engineer II Senior System Engineer Systems Engineering Architect Technical Writing: Technical Writer I Technical Writer II Senior Technical Writer Examples of Direct and Indirect Benefits Organizational Benefits Improves company reputation or market position Creates new market opportunities Allows the company to be more competitive Promotes company values and strategic decisions Meets legal and/or regulatory requirements Improves external customer relationships and quality of service Aligns IT operations with business needs Other Organizational Benefits Technical Benefits Improves systems reliability Improves systems security Improves systems performance Replaces legacy systems no longer supportable Updates systems to current levels Simplifies and streamlines technical support requirements Eliminates or reduces the reliance on external support or maintenance providers Helps to meet Service Level Objectives Meets new business requirements Improves ease of use for end-users Adds new functionality for end-users Other technical benefits Examples of Costs Capital Investment Hardware purchase (including warranty) Hardware upgrades Software licenses (> 1 year) Capital Improvements Other Capital Investment Operational Benefits Improves staff productivity by simplifying or streamlining operating procedures Creates new workflows/operating procedures Improves internal or external communications Reduces staffing requirements Reduces training requirements Eliminates or reduces the reliance on outsourced services Provides ergonomic or other environmental benefits Other operational benefits Financial Benefits Provides new sources of revenue Offers increased profitability for products and/or services Reduces production costs Improves cash flow Provides tax advantages Reduces maintenance and support costs Reduces facilities costs Reduces overtime costs Other financial benefits Business Costs or IT Costs Internal Labor Consulting fees and expenses 3rd party vendor / IT provider fees and expenses Software related annual expenses Leased hardware Conversions and data extracts Travel and related expenses Training development Training expenses Legal Costs One-time costs from disposal of existing assets Operations costs Maintenance costs Support costs Other recurring costs Other IT related costs Other Non-IT related costs 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls Helpful Tables Page 5 of 6 Printed: 8/12/2008 GMAC RFC Confidential Internal Use Only Instructions For Using The CBA Template 1) 2) 3) 4) Read the "CBA Standards & Policies" worksheet. Go to the "CBA Template" worksheet. Enter the requested data in the "Project Information" section. Enter in cell D11 the year equivalent to "Period 1" for the Cost Benefit Analysis. The future period year data will dynamically update based on the input in cell D11. The "CBA Template" displays five periods (in years). If the CBA measurement period extends further than five years, expand the grouped columns by clicking on the "+" sign above column N. Enter in cell D12 the number of months remaining in Period 1 (note, 12 months in Period 1 is the default). This data point will enable the Cash Flow Analysis section to properly calculate the Net Present Value and Internal Rate of Return. Enter Benefits and Costs labels and data in the appropriate sections of the template. Refer to the "CBA Template" cell comments as necessary. Additional background and explanations of financial concepts are also noted below. Document assumptions used in the Cost Benefit Analysis in the attached "Assumptions" worksheet. Refer to the "Helpful Tables" worksheet if this information is applicable to the project. Accept the default Discount Rate of 15% or overwrite it with an approved rate in cell B67. Select and click the "Calculate" button in cell D70. This macro will verify that the "Analysis ToolPak" is selected on your computer's Excel Tools/Add-in menu. The project Net Cash Flow and Cash Flow Analysis will calculate based on the above inputs. Note, for simplicity purposes, the CBA template shows costs and benefits before the impact of income taxes. If there are significant and/or unusual tax implications related to this project, those should be factored into this cash flow analysis. For this scenario, contact your financial representative for further instructions. Review the data and results of the Cost Benefit Analysis per inputs to the "CBA Template" and "Assumptions" worksheets. Complete the Signature & Approval section. 5) 6) 7) 8) 9) 10) 11) 12) Explanations Of Financial Concepts Discounting Concepts Discounting is based on the concept that investment funds have an opportunity cost, i.e. that they can earn a return if used on another project. Similarly, the funds used may have a cost to acquire them - the cost of capital. Whenever investment dollars are allocated to a project, every effort should be made to ensure that at a minimum they return what those funds cost or could have earned elsewhere. Ideally, investment projects should be selected because they earn more than the opportunity cost of the funds invested in that project. Capital Budgeting is the process by which the most desirable projects are selected in a competition for scarce investment dollars ($'s). Discounting can be thought of as a process by which the Financial Analyst is compensating for the time value of money. For purposes of this discussion, the time value of money will be referred to as the Discount Rate. Discount Rate The Discount Rate is the rate used to calculate the present value of future cash flows. A Discount Rate is required in the Net Present Value (NPV) and the Internal Rate of Return (IRR) calculations described below. This rate represents the cost of capital applicable to the cash flows being discounted. For projects that have the same risk as the company, the corporate Discount Rate is used. A higher or lower Discount Rate should be used if a project is either more or less risky than an average project. In instances where special financing is available, the Discount Rate should be adjusted to reflect the true after-tax cost of capital. Though RFC does not have a published Discount Rate, RCG Finance has suggested that a Discount Rate of 15% is reasonable and should be used when performing Discount Analysis. Present Value A concept central to the topic of Discounting is Present Value. Present Value represents the discounted value of future cash flows. A Present Value is the sum one would need today to achieve some specific future value, assuming a known interest rate (i.e. the Discount Rate) with annual compounding of the interest and principal. The reason that Financial Analysts are concerned with the Present Value of the Expected Cash Flows is that it allows them to compare the Initial Investment in today's dollars ($'s) with the Expected Cash Flows (i.e. net benefits) in today's dollars ($'s) thereby providing a standard of comparison that takes into consideration the time value of money. Net Present Value (NPV) Net Present Value (NPV) is another common method for determining the profitability of an investment. Net Present Value represents a project's net contribution to wealth by considering the present value of expected cash flows and the initial investment. In general, any investment that yields an NPV greater than zero (0) is considered profitable. However, funding approval for a given project will likely depend on how attractive its NPV is when compared to the NPV's of the other projects that are competing against it for funding. On the "CBA Template" worksheet, the Net Present Value of expected cash flows (i.e. net benefits) to the organization in Periods 1 through x is calculated and appears in the Cash Flow Analysis section. When the NPV over the timeframe of the project is positive, the sum of projected cash inflows over time exceed the total investment outlay in today's dollars. Net Present Value, like Internal Rate of Return, is used to compare one investment opportunity with another. A major difference between the two is that NPV provides the reader with a sense of the dollar ($) impact of the investment while IRR does not. In accounting terms, Net Present Value represents the difference between the Present Value Of Expected Future Cash Flows minus the Present Value Of The Initial Investment. Another way to express this is by saying that NPV indicates the dollar amount of valuation added to the company by taking on a given project . Internal Rate of Return The Internal Rate of Return (IRR) of an investment is the rate that causes the net present value of the investment to equal zero. In other words, the IRR is the rate that causes the present value of the inflows from an investment to exactly equal the cost of the investment. Internal Rate of Return, like Net Present Value (NPV), is used to compare one investment opportunity with another. An attractive investment is one whose NPV, discounted at the appropriate hurdle rate, is greater than zero (0). Turn that equation around and you can see that the interest rate required to generate a Net Present Value of zero must be greater than the discount rate. Thus, an attractive investment is one for which the interest rate required to yield a NPV of zero (0) —that is, the IRR—is greater than the Discount Rate. Suppose that you are presented with an opportunity to invest in a system enhancement that is estimated to cost $80,000 and is expected to save the organization $25,000 per year over the next five (5) years. Would this investment promise an acceptable return if the discount rate is set at 15%? Using the "CBA Template" worksheet, you learn that the IRR is approximately 17%. This means that this investment will return 2% more (17% - 15%) than would have been gained by investing the $80,000 at 15% interest during the same period. Since the IRR is marginal, approval of this project will depend on whether or not other project(s) competing against this project for funding will yield greater Internal Rates of Return. 6e9c0fc2-447e-4e3a-9503-7a6a4475667c.xls Instructions Page 6 of 6 Printed: 8/12/2008