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Life Cycle Cost Analysis

The document discusses life cycle cost (LCC) analysis. LCC is the process of assessing the total cost of owning a product over its entire lifecycle, including costs of installation, operation, maintenance, conversion and decommissioning. The key steps in LCC analysis are: 1) determining the product lifecycle timeframe, 2) estimating costs for each period, 3) calculating the present value of costs, 4) summing present values to get the LCC for each year, and 5) analyzing results. LCC provides important inputs for decision making regarding product design, development, use and comparing alternatives. The document includes an example LCC case study comparing two machine options.

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Jayaprakash Sankaran
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141 views39 pages

Life Cycle Cost Analysis

The document discusses life cycle cost (LCC) analysis. LCC is the process of assessing the total cost of owning a product over its entire lifecycle, including costs of installation, operation, maintenance, conversion and decommissioning. The key steps in LCC analysis are: 1) determining the product lifecycle timeframe, 2) estimating costs for each period, 3) calculating the present value of costs, 4) summing present values to get the LCC for each year, and 5) analyzing results. LCC provides important inputs for decision making regarding product design, development, use and comparing alternatives. The document includes an example LCC case study comparing two machine options.

Uploaded by

Jayaprakash Sankaran
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Life Cycle Cost Analysis

Life Cycle Cost (LCC)

Life cycle costing, LCC, is the


process of economic analysis to
asses the total cost of ownership
of a product, including its cost of
installation, operation,
maintenance, conversion, and/or
decommission.

Life Cycle Cost (LCC)

By using LCC, total cost of the


product can be calculated over
the total span of product life
cycle.

Life Cycle Cost (LCC)

LCC is a economic tool which


combines both engineering art
and science to make logical
business decision.
This analysis provides important
inputs in the decision making
process in the product design,
development and use.

LCC for product supplier

By using LCC, product suppliers


can optimize their design by
evaluation of alternatives and by
performing trade-off studies.
By using LCC, product suppliers
can evaluate various operating
and maintenance cost strategies
(to assist product users).

LCC for customer

By using LCC, customers can


evaluate and compare
alternative products.
By using LCC, customers can
assess economic viability of
projects or products.

Why use LCC?


Typical conflict in most of the company:

Project Engineering wants to minimize


capital costs as the only criteria,
Maintenance Engineering wants to
minimize repair hours as the only criteria,
Production wants to maximize operation
hours as the only criteria,
Reliability Engineering wants to nullify
failures as the only criteria,
Accounting wants to maximize project net
present value as the only criteria,
Shareholders want to increase stockholder
wealth as the only criteria.

Why use LCC?

LCC can be used as a


management decision tool for
synchronizing the divisional
conflicts by focusing on facts,
money, and time.

Why use LCC?

Why should engineers be concerned


about cost elements?
It is important for engineers to think
like managers and act like
engineers for a profit maximizing
organization.

Money Does Matter!!!

Cost element

For an equipment, there are TWO


cost elements:

1) Initial Cost, and


2) Operation & Maintenance
Cost

The identification of cost elements and


their sub-division are based on the purpose
and scope of the LCC study.

Cost element

Initial Cost:
Design & development cost,
Investment on asset, or cost of
equipment,
Installation cost or erection &
commission cost.

Cost element

Operation & Maintenance


Cost:
Labour cost,
Energy cost,
Spare & maintenance cost,
Raw material cost.

Computation
of
Life Cycle Cost Analysis
(Steps for LCCA)

Steps for computation of


LCC

Step 1: Determine time for each cost


element,
Step 2: Estimate value of each cost
element,
Step 3: Calculate Net Present Value of
each element, for every year (over its
time period),
Step 4: Calculate LCC by adding all cost
element, at every year,
Step 5: Analyze the results.

Step 1: Determination of
time
Determination of life cycle of

the product (i.e. equipment, in


this case).
This Life cycle is not similar to conventional
concept of Product Life Cycle.
Conventional concept of Product Life Cycle
implies to the time span based on demand
of the product in the market, starting from
launch of the product up to the time when
company withdraw the product from the
market. That is purely a marketing concept.
To be continued

Step 1: Determination of
time
In LCC analysis of an equipment, life cycle

means the life of the product that is installed


in the plant, i.e. productive life time of the
product.
The product supplier provides the life cycle
depending on design calculation and
experience.
Based on suppliers data, customer decides
the Life Cycle, i.e. how long he/ she wants to
use the machine. Customer considers the
effect of available maintenance facility,
technological obsolescence and economic
uncertainty factor, also.
To be continued

Step 1: Determination of
time
After that, company decides the time

span for each component.


Example, say, a company decides
that total life cycle of the product will
be 10 years from the allocation the
fund, among which first one year will
be initial cost zone and remaining 9
years will be under operation and
maintenance cost zone.

Step 2: Estimation of value


Estimate monetary value for each

cost element.
This estimated value will be
incurred in every year. This value is
basically future income at each
year, which is estimated.
To estimate the value, various
source can be used; e.g. calculation
based on facts and experience, MIS
report for similar existing machines,

Step 3: Net Present Value


Money has a time value.
The present value of future income

or future cost can be calculated by


using discounting factor and
inflation factor.

To be continued

Step 3: Net Present Value

Discount factor
The discount rate is an interest rate,

a central bank charges depository


institutions that borrow reserves from
it.

For example, let's say Mr. Ram expects Rs.

1,000 inone year's time.To determine the


present value of this Rs. 1,000 Ram would
need to discount it by a particular rate of
interest (often the risk-free rate but not
always). Assuming a discount rate of
10%,theRs. 1,000 in a year's time would
To be continued
beequivalent of Rs. 909.09 to Ram
today (i.e.

Step 3: Net Present Value

Inflation factor
The inflation rate is the percentage

by which prices of goods and


services rise beyond their average
levels. It is the rate by which the
purchasing power of the people in a
particular geography has declined in
a specified period.
To be continued

Step 3: Net Present Value

Formula for Net Present Value (NPV)

C (1+i/100) (n-1)
PV= ----------------------(1+d/100) n
where,
C = any cost element at nth year
I = inflation rate
d = discount rate/ interest rate

Step 4: Summation of PVs

PVs of each cost elements is


calculated for an equipment (at every
year).
PVs of each cost element in a year are
added.
The process is done for every year
over the life cycle, i.e. LCC is
calculated for every year.

Step 5: Analysis

The datas collected from LCC are


analyzed.
If one product has to be selected
among multiple equipments, then LCC
is calculated for every product.
Datas for every product are analyzed,
and the lowest LCC option become
preferred.
But lowest LCC option may not
necessarily be implemented when other
considerations such as risk, available
budgets, political and environmental

An important reminder..
LCC provides critical information to
the overall decision-making
process, but not the final answer.

Estimation
of
Life Cycle Cost
With a typical case study!

Case Study

1.

A highly productive foundry shop


has one sophisticated robot
operated core making machine
(made in Italy).
Due to increase of demand for its
casting, the foundry shop wants to
install one new core making
machine.
For new machine, there are two
options:
Similar sophisticated robotic

Option 1

Initial cost

Sl.
No
.

2
3

Cost Element

Value
(in
INR,
million
)/ year

Time
phas
e

Design &
development
(D)
Investment on
asset (A)
Installation (I)

59.4
0.6

Remarks

Bought
out item

0-1
year
0-1 1% of

Option 1

Initial cost (IC)


Computation of PV of IC

D(1+i/100) (n-1)
A(1+i/100) (n-1)
I(1+i/100) (n-1)
PV= ------------------------ + ---------------------- + ----------------------(1+d/100) n
(1+d/100) n
(1+d/100) n
n is the year on which PV will be calculated, here n=1 year, only

Interest rate, d=8%


Inflation rate, i=5%

0(1+5/100) 0
59.4(1+5/100) 0
0.06(1+5/100)
PV= ----------------------- + ------------------------ + --------------------(1+8/100) 1
(1+8/100) 1
(1+8/100) 1

From calculation, PV of IC = 55.5 million


INR

Option
1

Operation & Maintenance Cost

Sl.
No
.

Cost Element

Value
(in INR,
million)/
year

Time
phase

Remarks

Labour (L)

0.3

2-10
year

4 workers
@ 3 shifts

Energy (E)

2-10
year

Spare &
maintenance (S)

2.6

2-10
year

Raw material (M)

27.7

2-10
year

MIS report
of existing
equipment,
as new
equipment
is identical

Option 1

Operation & Maintenance cost (OC)


Computation of PV of OC
Total OC= L+E+S+M=34.6 Million INR
PV of OC at nth year,

OC(1+i/100) (n-1)
PV= -----------------------(1+d/100) n

Cumulative value of OC after nth year (in terms


of PV)
=

OC(1+i/100) (n-1)
-----------------------(1+d/100) n

PV of OC and cumulative OC at different year


to be calculated by using this formula.

Option 1

COMPUTATION OF LCC: TABLE 1

Operation & Maintenance cost (OC)


Time
Period

Discounting
factor

nth
year

1/(1+8/100)

Inflation
factor
(1+5/100)

n-1

Future
OC at nth
year
Million
INR

PV of any
year

Total PV
incurred

Initial
Cost (IC)

Total LCC

Million INR

Million INR

Million
INR

Million INR

H=G+F

E=DXBXC

F=E+ last
year's F

55.50

55.50

0.86

1.05

34.60

31.15

31.15

55.50

86.65

0.79

1.10

34.60

30.28

61.43

55.50

116.93

0.74

1.16

34.60

29.44

90.87

55.50

146.37

0.68

1.22

34.60

28.62

119.49

55.50

174.99

0.63

1.28

34.60

27.83

147.32

55.50

202.82

0.58

1.34

34.60

27.05

174.38

55.50

229.88

0.54

1.41

34.60

26.30

200.68

55.50

256.18

0.50

1.48

34.60

25.57

226.25

55.50

281.75

10

0.46

1.55

34.60

24.86

251.11

55.50

306.61

Option 1

Computation of LCC
In the previous calculation, expected
future values of OC at all the years
were same, i.e. 34.6 Million INR.
This expected value can be different
for different years, too.

Option 2

Different cost element for option 2


(i.e. Semi-automated machine) has
been estimated and final calculation
for LCC has been done.

Option 2

COMPUTATION OF LCC: TABLE 2


Operation & Maintenance cost (OC)
Inflation
factor

Future
OC at
nth year

(1+5/100)

Million
INR

Time
Period

Discounting
factor

nth
year

Total PV
incurred

Initial
Cost (IC)

Total LCC

Million INR

Million INR

Million
INR

1/(1+8/100)

Million INR

E=DXBXC

F=E+ last
year's F

H=G+F

42.00

42.00

0.86

1.05

50.00

45.01

45.01

42.00

87.01

0.79

1.10

50.00

43.76

88.77

42.00

130.77

0.74

1.16

50.00

42.54

131.31

42.00

173.31

0.68

1.22

50.00

41.36

172.68

42.00

214.68

0.63

1.28

50.00

40.21

212.89

42.00

254.89

0.58

1.34

50.00

39.10

251.99

42.00

293.99

0.54

1.41

50.00

38.01

290.00

42.00

332.00

0.50

1.48

50.00

36.95

326.95

42.00

368.95

10

0.46

1.55

50.00

35.93

362.88

42.00

404.88

n-1

PV of any
year

Analysis

Analysis

The analysis shows:


initial cost of semi-automated machine is

lower.
But, the long term LCC is much lower for
Robotic machine.

Considering LCCA, the robotic


machine is preferred compared to the
semi-automated machine, for this
particular application.

Capital Budgeting & LCC

LCC is one of the important tool for


capital budgeting.
Economist Joel Dean has suggested
that, capital expenditure should be
defined in terms of economic
behaviour rather than in terms of
accounting convention.
LCC is one of the useful tool which
enables investors to analyze
investment in terms of economic
behaviour.

Thank you.

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