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.

 LCC

Why use
LCC?

can be used as a
management decision tool for
synchronizing the divisional
conflicts by focusing on facts,
money, and time.

Why use
Why should engineers be concerned
LCC?
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.

 Initial

Cost
element

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
time
In LCC analysis of an equipment,of
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, etc.

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 beequivalent of Rs. 909.09 to Ram
today (i.e. 1000/[1+0.10]).
To be continued

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

Formula for Net Present Value (NPV)
Value
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 of each cost elements is calculated
PVs
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:
The datas collected from LCCAnalysis
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 concerns are taken into
account.

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!

1.
2.

Case
Study
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 machine, or
Semi-automated machine.

 Initial

Sl.
No.

2
3

Option
1

cost

Cost Element

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

Value Time Remarks

(in INR, phase
million)
/ year

59.4
0.6

Bought
out item

0-1
year
0-1 1% of
year asset cost

Initial cost (IC)

Computation of PV of IC

Option
1

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

 Operation

Sl.
No.

& Maintenance Cost

Cost Element

Value

(in INR,
million)/
year

Time
phase

Option
Remarks1

Labour (L)

0.3

2-10 4 workers @
year 3 shifts

Energy (E)

Spare &
maintenance (S)

2.6

Raw material (M)

27.7

2-10 MIS report

year of existing
equipment,
2-10
as new
year
equipment
is identical
2-10
year

Option
Operation & Maintenance cost (OC)
1
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

n year

1/(1+8/100)

th

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

 Computation

Option
1

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)

Time
Period

Discounting
factor

n year

1/(1+8/100)

Inflation
factor

Future
OC at nth
year

PV of any
year

Total PV
incurred

Initial
Cost (IC)

Total LCC
Million INR

Million
INR

Million INR

Million INR

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

th

(1+5/100)

n-1

Analysi
s

 The

analysis shows:

Analysi
s

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 is one of the important tool for LCC
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.