What to include in return-on-investment calculations is an important question because the results play a vital role in securing project approval and in choosing among various options. 

Performing an ROI calculation is straightforward: just set up a spreadsheet with the costs and benefits you will see each year as a result of the project, calculate the resulting time-value-of-money (present value) each year, and then run ROI and other financial calculations for the series of net incomes. Figure 1 shows an example spreadsheet. 

Doing the calculation is easy; the hard part is getting the data right — incorporating all the project’s benefit and cost factors and accurately estimating them.

If you are working on a new plant or system, then you will probably be comparing various vendor options. Don’t just look at the upfront price; be sure to include the different benefits and ongoing costs of each option.

Alternatively, if you are replacing an old system, then you also have to sell the idea, and the new system will need substantial benefits to justify the project expense. Cost reductions, such as lower system downtime, less energy consumption, fewer product shortages, and fewer product quality issues, should be included. In addition, reduced maintenance costs, including spare parts, repairs, and service work, can offer substantial savings.

To estimate those benefit and cost factors, you have to dig into financial information that should be available from your management or finance group. Energy usage for each motor can be calculated if you know its horsepower, the number of hours it runs per day, and the cost per kilowatt-hour for your electric service, which can be found on your electric bill or by doing a Google search for your location.

If the current system is causing headaches, such as process downtime, the cost estimate should include both direct and indirect downtime costs. Direct costs include lost revenue and idle labor multiplied by the duration of the disruption. Indirect costs, such as startup expenses, maintenance, or contractual penalties, are usually applied once per shutdown. Don’t forget to include the cost of scrap or reduced-quality product caused by the downtime. Outages can also cause long-term harm, such as customer dissatisfaction and lost business opportunities.

If the new system will improve product quality, then calculate the cost of poor quality for both the old and new systems and then calculate the savings. The cost of poor product quality includes scrap (product that must be discarded), rework or repairs (usually requiring labor or extra materials to make them usable), and reinspection (additional high-quality manpower and processes).

If your project calculation includes labor savings, then don’t forget to include the cost of employee benefits and overhead that will be reduced as well. These often amount to 30% to 45% of wages. Adding employee benefits and overhead will not only make your analysis more accurate, but the resulting higher labor savings will also make your project easier to justify. Your personnel department can give you a rule-of-thumb multiplier (as a percent of wages) for your company or department.

Some other project benefits may be difficult to quantify, such as improved safety, less pollution, less reliance on a few suppliers, and less employee frustration. These advantages should be included in your list of benefits even if you can’t put a price tag on them.

In summary, remember that the true cost of ownership includes not only the upfront costs but also the ongoing costs that occur every year. Making good estimates is not easy, but it is worth the effort. Not only will you get a more accurate cost justification, you will also learn a lot about your company’s business and make yourself more valuable to the company!