Cost-Benefit Analysis of Computer Purchase for Small Business

Introduction

In today's commercial environment, it is necessary that small as well as large businesses remain competitive. For every investment there will be an opportunity cost, so it is essential that potential investments are assessed to help maximize value creation. One approach frequently used is the cost-benefit approach, which measures costs and benefits based on the underlying principle that an investment or project should only proceed if the benefits are greater than the costs incurred. If a small business is considering investing in a computer, a cost-benefit analysis may help assess whether the investment is likely to be beneficial.

This analysis begins with the assessment of costs to be incurred and potential benefits. In this case, it is assumed that a business such as an independent shop is considering purchasing a computer to increase efficiency for counting and record-keeping, as well as to facilitate an expansion strategy into e-commerce, allowing the business to sell online.

Identifying and Calculating Costs

The computer selected as suitable for the small business is a Dell OptiPlex mini tower. It is essential that all requirements are considered, not just the cost of the core computer. All items assessed as required are taken from the Dell website. The computer is a starting point, but it is also necessary to look at the additional hardware, software, and support needed. For example, a computer system requires a monitor, speakers, and a printer. As the business will rely on a computer, it is also advisable to ensure there is sufficient technical support with a service agreement. The costs include an extended warranty for both the computer and printer, and accident insurance so that replacements can be made if needed. The software included is Microsoft Office, as well as a three-year Dell data protection and encryption license.

Table 1: Initial Costs

The next stage is to consider the benefits that will emerge as a result of the investment. The benefits will not be immediate but will accumulate over time. In this assessment, it is assumed that the computer will have a useful life of three years, after which it will need to be replaced. Therefore, the cost-benefit analysis is based on a three-year period. Since benefits accumulate over three years, the initial assessment is based on annual benefits.

Quantifying Benefits Over Time

There are several potential sources of benefit. First is the ability of the firm to undertake an e-commerce strategy, which will increase sales. The development of forecasts accounts for the way in which sales will be low in the first year and grow over time. The benefit from online sales is the net benefit to the firm, measured as the increase in net profit (sales less costs) expected to occur as a result of the new strategy facilitated by the computer. This figure also allows for the possibility that some traditional customers may move to the online sales medium.

In addition to e-commerce benefits, there may also be increases in traditional sales. With the firm's ability to establish a web presence through a webpage and social media presence, the firm can undertake cost-effective marketing to support gaining traditional customers who will visit the shop. The increase in net profit as a result of these sales is also included in the benefits.

The ability of the business owner to save time is a convenience, but it can be difficult to monetize. However, if a total of 2 hours are saved per week, this may result in the ability to reduce employee hours by 1 hour, which is a cost saved and can be included. It is assumed that 1 employee, at a total cost of $12 per hour, can be calculated as a benefit. It is assumed that wages will rise by 5 percent per annum. The net benefits for each of the three years are shown in Table 2.

Table 2: Benefits

Simple Cost-Benefit Assessment

This initial analysis would appear to indicate that there is a benefit to the purchase, as the benefits are greater than the costs. In this case, there is a net benefit of $1,991.30, as shown in Table 3.

Net Present Value Analysis

Table 3: Net benefit of computer purchase

The simple calculation indicates that the investment appears worthwhile. However, this does not account for the time value of money; the value of $100 today is not the same as the value in the future, due to inflation. Therefore, a cost-benefit analysis that does not account for how the value of money erodes over time may be misleading. This can be addressed by examining the net present value assessment. This is an appraisal that takes the value of money from future years and discounts it into today's terms.

The equation starts with the discounting of each year's cash flow or benefit. The equation is PV = FV / (1+r)n, where FV is future value or benefit, r is the discount rate, and n is the number of years away from the current time period. The benefit levels for each year have already been calculated. The only missing data is the discount rate. For this analysis, the discount rate applied is 5 percent. This can be based on the expected inflation rate, and for firms with borrowing, it may be assessed using the weighted average cost of capital.

The forecast net present value of the project is shown in Table 4, where each year's benefits are calculated using the discount rate. After the discounted benefits are added together, the full cost of the investment is deducted.

Table 4: Net present value

Conclusion

This shows that there is still a positive outcome; the benefits are greater than the costs. However, the benefits are not as great as the initial calculation due to the time value of money. It is also important to remember that this net present value is speculative, as it is based on the assumption of a 5 percent inflation rate or cost of capital. This assumption can change, and as such there is the ability to apply a higher discount rate to ensure that there would remain a positive value even under less favorable conditions.