Lecture#07

Engineering Economics
By Lec. Junaid Arshad
1

Life Cycle Cost (LCC)

LCC is defined as all costs, both non recurring and recurring, that occur over the life cycle.
During the acquisition phase, non recurring costs are incurred, and these constitute the first cost of the structure or system. During utilization phase, recurring costs are experienced.

Cost Generated over the Life Cycle

Many systems and products are planned, designed, produced and operated with very little concern for their life cycle cost. Although different aspects of cost have been considered in the development of new systems these costs have often been viewed in a fragmented manner. The costs associated with activities such as research, design, testing, production or construction, consumer use and support have been isolated and addressed at various stages in the product life cycle, and not viewed on an integrated basis.
3

In general the elements of life cycle cost fall into categories that are based on organizational activity over the life cycle. These are illustrated in the figure below.

Large portion of the total cost for many systems is the direct result of activities associated with their operation and support, while the commitment of these costs is based on decisions made in the early stages of the system life cycle. Further costs associated with the different phases of the life cycle are interrelated. While addressing the economic aspects of a system one must look at total cost in the context of the entire life cycle.

Cost Commitment over the Life Cycle

Throughout the system/product life cycle there are many actions required. The majority of the actions, particularly those at the earlier stages, have life cycle implications and definitely affect life cycle cost. Life cycle cost and economic analysis should originate early in the product life cycle during conceptual and preliminary design. The figure illustrate a characteristic cumulative life cycle cost curve related to action occurring during the various phases of the life cycle.

As illustrated more than half of the projected life cycle cost is committed by the end of the system planning and conceptual design even though actual expenditures are relatively minimal by this point in time.
7

The Time Value of Money

Because money can earn at a certain interest rate through its investment for a period of time, one thousand rupees received at some future date is not worth as much as in hand at present. This relationship between interest and time leads to the concept of the time value of money.

One thousand rupees in hand now is worth more than one thousand rupees received n years from now. Why?
Because having one thousand now provides the opportunity for investing that for n years more than the one thousand to be received at that time.
8

Since money has earning power, this opportunity will earn a return, so that after n years the original one thousand plus its interest will be greater than the one thousand received at that time. Thus, the fact that money has a time value means that equal amounts at different points in time have different value as long as the interest rate that can be earned exceeds zero. This relationship between money and time is illustrated in fig.

It is also true that money has time value because the purchasing power of a thousand changes through time. During periods of inflation the amount of goods that can be bought for a particular amount of money decreases as the time of purchase occurs further out in the future.
Therefore, when considering the time value of money it is important to recognize both the earning power of money and the purchasing power of money.
10

The Earning Power of Money

Funds borrowed for the prospect of gain are commonly exchanged for goods, services, or instruments of production. This leads to the consideration of the earning power of money that may make it profitable to borrow.

11

The Purchasing Power of Money

As prices increase or decrease, the amount of goods or services that can be purchased for a fixed amount of money decreases or increases accordingly. Prices for goods and services are driven upward or downward because of numerous factors at work within the economy. For example, increases in productivity and in the availability of goods tend to reduce prices, while government policies tend to increase prices. When all such effects are taken together , the most common result has been that prices increase.
12

GENERAL PRICE INFLATION

An increase in the average price paid for goods and services bringing about a reduction in the purchasing power of money.

GENERAL PRICE DEFLATION

A decrease in the average price paid for goods and services, resulting in an increase in the purchasing power of money.

13

DEPRECIATION
Decrease in value of physical properties with passage of time and use Accounting concept establishing annual deduction against before-tax income - to reflect effect of time and use on assets

value in firms financial statements - to match yearly fraction of value used by asset in production of income over assets economic life
14

PROPERTY IS DEPRECIABLE IF IT MUST :

be used in business or held to produce income have a determinable useful life which is longer than one year wear out, decay, get used up, become obsolete, or lose value from natural causes not be inventory, stock in trade, or investment property

15

DEPRECIABLE PROPERTY

TANGIBLE - can be seen or touched personal property - includes assets such as

machinery, vehicles, equipment, furniture, etc... real property - anything erected on, growing on, or attached to land (Since land does not have a determinable life itself, it is not depreciable)

INTANGIBLE - personal property, such as copyright, patent or franchise

16

WHEN DEPRECIATION STARTS AND STOPS

Depreciation starts when property is placed in service for use in business or for production of income Property is considered in service when ready and available for specific use, even if not actually used yet Depreciation stops when cost of placing it in service is removed or it is retired from service

17

18