Quantifying the value of IT-investments

• Authors: C. Verhoef
• Venue: Science of Computer Programming
• Year: 2005

We described a method to quantify the value of investments in software systems. For that, we adopted the classical risk-adjusted discounted cash flow model and geared it towards the field of information technology. This resulted in a scenario-based approach incorporating two IT-specific risks that can substantially influence IT-appraisals. They are requirements creep and time compression. To account for the risk of failed IT-projects and overrun risks we proposed the Weighted Average Cost of Information Technology (WACIT). WACIT adjusts the well-known Weighted Average Cost of Capital, commonly used in discounted cash flow models. We proposed several methods to approximate WACIT ranging from an investment-specific rate to a (company-wide) one inferred from a quantitative IT-portfolio analysis. We illustrated our quantitative IT-investment management approach by way of a published example. For various risk-scenarios, we calculated using this example the impact on the firm's share price, standard economic indicators like NPV, IRR, PBP, ROI, RAROC, and more, in order to come to grips with the appraisal of information technology--the largest production factor of today.