What is the Life Cycle Cost Analysis?
Life Cycle Cost Analysis is used to examine and assess the total cost of resource ownership and takes into account expenses related to buying, maintaining, operating and disposing of a project or an object. It is used especially to select the best project when there are multiple projects that satisfy the same performance requirements, but differ in terms of operating costs and initial costs which must be compared for selecting the method for maximization of net savings.
The purpose of this analysis is the estimation of the overall cost of project options and then select the designs which can ensure the facility to provide the overall lowest cost of ownership constant with the function and its quality. The analysis should be performed at an early stage so that there will be chances of refining the design to ensure the reduction in life cycle total cost. The most challenging assignment of this analysis or any economic evaluation technique is to ascertain the economic effects of alternate designs of a building system or buildings and quantify these effects in the monetary terms. However, the LCCA is useful for the economic impact of the options available in the industry. The process involves assessing cost arising from the assets of the company over some time and evaluating alternatives which impact on the cost ownership.
Life Cycle cost analysis appropriately weighs the money spent today as compared to money spent in the future. Each cost should be converted into dollars and then summed up to create a total cost in current dollars for each specified alternative. This quantity is sometimes preferred as total cost or the net present value of the current dollar. With the net present valueNet Present ValueNet Present Value (NPV) estimates the profitability of a project and is the difference between the present value of cash inflows and the present value of cash outflows over the project’s time period. If the difference is positive, the project is profitable; otherwise, it is not. calculated for the alternative, the comparison is easy because units are constant. The best option is simply the alternative with the net present value or lowest life cycle costLife Cycle CostLife Cycle Costing is a method that aggregates all costs that an organization or individual will incur over the life span of the asset, project, investment etc. It includes initial investment and any further investments such as operating cost, maintenance and repair, upgrades (recurring expenses)..
The basic formula is:
LCC = C+PV Recurring – PV Residual Value
- LCC is the life cycle cost
- C is the 0-year construction cost
- PV recurring is the present value of all recurring cost
- PV residual value is the present value of residual valueResidual ValueResidual value is the estimated scrap value of an asset at the end of its lease or useful life, also known as the salvage value. It represents the amount of value the owner will obtain or expect to get eventually when the asset is disposed. at the end of the project.
Example of Life Cycle Cost Analysis
Let’s take an example if Mr. A wants to purchase a printer for the business purpose.
- Purchase: The price is $2000.
- Installation: Pend an additional $50 for setting up and delivery purposes.
- Operating: Spend $900 for ink cartridges and paper for it. The total cost of electricity will be expected at $300.
- Maintenance: Repairs will cost $500.
- Financing: Credit card interest rate of 4% per month. (2000*4%)
- Depreciation: Value will be reduced by $100 each year.
- Disposal: Estimation of hiring a contractor to remove the printer is $ 150.
Hence the price of the printer is $ 2000 but the life cycle cost of the printer will end up costing the business more than $2000.
Life Cycle Cost Analysis Diagram
The life cycle cost analysis diagram represents the working of the whole cycle as it includes all the activities which are necessary for better results. This shows the stepwise procedure of life cycle cost and how it will impact the business on a large scale. It is the easiest way of accumulating the cost as per the specified time.
Following are the benefits of the analysis:
- It will result in earlier actions for the generation of revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions..
- Lower costs than other methods or techniques.
- It shows an accurate and realistic assessment of costs and revenue within a specified life cycle stage.
- It promotes long-term worthwhile.
- It gives an opportunity for total incremental costs over the whole span of time.
- It will provide management awareness of the resources required to be purchased and the drive cost of it.
- This technique will not only focus on the cost but also other factors like the quality of goods and the services that must be provided.
- Time-Consuming: This analysis is way too long because of changes in the new technology with future stability.
- Costly: The longer project means the long-time duration which makes it more costly than other methods.
- Technologically Outdated: As technology changes day today so it provides the possibility of outdated technology.
- Less Reliable: It is not a reliable method for facts and figures because some data are assumed by the companies for the calculation of life cycle cost.
This has been a guide to Life Cycle Cost Analysis. Here we discuss purpose, formula, and example of life cycle cost analysis along with benefits and disadvantages. You may learn more about financing from the following articles –