Computing Return on Investment (ROI)
Oracle Tips by Burleson Consulting
The Data Warehouse Development Life Cycle
COMPUTING RETURN ON INVESTMENT (ROI)
Here, you enter the realm of the time value of money. Because you
will have to wait a year to acquire the additional $50 in benefit,
you need to consider your opportunity cost of capital. That is, if
you freed-up your $20 investment by an immediate sale, how much
additional revenue could you generate by having that $20 to invest
in other antiques? To know the answer, you must computer your
opportunity costs and determine the relative merits of each option.
In corporations, the opportunity cost of capital has been carefully
computed, and the answer can be determined by applying the
discounting factor associated with the opportunity cost of capital
to the future revenues.
The discounting factor must take into account more than just the
opportunity cost of capital. For example, if our current inflation
rate is 10 percent, then you must also factor this into your
decision. The intangible costs of risk are also sometimes factored
into a discounting rate. Remember, you are dealing with the
probability that your Parrish print will take one year to sell for
$250, and your confidence in this estimate must also be taken into
account. If you are 95 percent certain that the print will sell
within one year, then there is a 5 percent possibility that the
print will remain in the store for a period longer than one year,
and you must factor this risk into your equation.
Applying the discount rate to future costs and benefits is not as
simple as subtracting the future amount by the percentage discount
rate. When computing the net present value of a cost or benefit, you
must recognize that the discount rate is applied in an iterative
fashion according to specific time periods. For example, your
opportunity cost of capital might be the rate of return that you
could earn from a certificate of deposit that pays 8 percent
compounded yearly. If this were the case, then you would reapply
your discount rate on a yearly basis. However, matters get more
complicated when opportunity costs are compounded more frequently.
Some financial institutions pay interest compounded monthly, daily,
and even continuously. In our picture example, the opportunity costs
might be the inability to purchase other antiques which may sell
faster, or at a higher profit margin.
Usually, the data warehouse manager can call the accounting
department and ask for the discount rate for the company and the
periods for the rates. Then, it is a simple mater of using net
present value techniques to compute the present values of costs and
Regardless of the method, all of the return on investment
calculations should result in a net dollar value. Remember, when
doing a cost-benefit analysis, you must take into account the total
accrued future costs and benefits, all the while expressing the
terms in net present value dollars. Quantitatively, this involves
using calculus to determine the space under the cost and benefit
This is an excerpt from "High Performance
Data Warehousing", copyright 1997.
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