Life Cycle Cost Analysis

What is Life Cycle Cost Analysis (LCCA)

Life Cycle Cost Analysis (LCCA) is a method used to evaluate the total cost of owning and operating a project over its entire lifespan. This analysis is particularly useful when comparing multiple project alternatives that meet the same performance objectives but differ in initial and operational costs.

The goal of LCCA is to identify the alternative that offers the maximum savings over time. While some projects may have higher upfront costs, they can lead to significantly lower operational expenses and overhead throughout their lifespan. 

Contrarily, other projects might have lower initial costs but incur higher operational expenses over time. LCCA helps investors optimize their decisions by focusing on minimizing total costs over the project's life cycle.

It’s important to note that LCCA is specifically focused on cost analysis and is not used for resource distribution.

There are many methods of economic valuation, such as:

• Net Savings (NS)
• Savings-to-Investment Ratio (SIR)
• Internal Rate of Return (IRR)
• Simple Payback Period (SPD)
• Discounted Payback Period (DPD)
• Life-cycle cost (LCC)

All of the project economic valuation methodologies arrive at the same answers given the same parameters and length of time, however, the most straightforward and easiest to interpret is LCC.

LCCA is usually under the responsibility of anyone involved in:

• Cost Estimating
• Value engineering
• Economic analysis

This largely includes building economists, value specialists, cost engineers, architects, quantity surveyors, and operations researchers.

Life Cycle Cost Calculation

The equation for LCC is expressed as:

LCC = C + PV Recurring - PV Residual

Where:

• ‘LCC’ is the life cycle cost
• ‘C’ is the initial cost on year 0
• ‘PV Recurring’ is the present value of all recurring costs
• ‘PV Residual’ is the present value at the end of the project

Or 

LCC = I + Repl - Res + E + W + OM&R + O

Where:

• ‘I’ is the price of the PV (present-value) investment at the base date (does not need to be discounted)
• ‘Repl’ is the capital replacement cost for ‘I’
• ‘Res’ is the PV residue value less disposal costs
• ‘E; = PV of energy costs
• ‘W’ = PV of water costs
• ‘OM&R’ = PV of non-fuel operating, maintenance and repair costs
• ‘O’ = PV for additional costs

LCCA Equation Variables Explained

The LCC equation has variables that are aggregated up. Those variables will be explained in detail below.

Initial costs (‘I’)

Capital investments for land acquisition, construction, or improvement of existing infrastructure. The equipment needed to operate the facility 

Land acquisition costs need to be included in the initial cost estimate already. However, not all projects require land acquisitions, as projects exist where only renovations of a concurrent facility are needed or if the land was already owned.

Construction costs are a little contradictory because although they are part of the initial costs, such estimates aren’t even available until the design becomes well into development to the point where the opportunity for cost-reducing design changes has been missed.

To at least hamper the effects of letting costs explode, ideally, LCCA would be repeated every time new design information becomes available. 

Utilities (‘E’) (‘W’)

Operational expenses involving energy and water. Utilities involve consumption and current rates and thus have price projections.

Energy consumption and to a lesser extent, water consumption are independent of infrastructure configuration.

Energy and water costs are accessed with the overall infrastructure rather than individual systems or components.

Energy prices: Most locations will have a dedicated wholesale provider that sells power at commercial rates, so there isn’t much to choose from. Certain areas have access to retail electric providers where you would have to obtain an estimate that is as close to the actual cost as possible. 

There are many assumptions such as current quotes from suppliers, rate type, rate structure, seasonal price changes, block rates, and demand charges.

Energy price projections: Energy prices become variable after their fixed-rate contracts expire, so energy rate changes are assumed to rise and fall at different rates than inflation. This delta must be considered when estimating future energy costs.

Water costs: Water costs are treated almost identically to energy with the only difference being that water is divided into water usage costs and water disposal costs. These projections are more geographically based.

Operational, Maintenance, and Repair (‘OM&R’)

Estimating the non-utility operating expenses involved in building expenditures. Even if projects have identical types and ages, operating schedules always vary.

Engineers are needed to make judgment calls when estimating these costs.

Fortunately, OM&R estimates are usually provided by suppliers. These resources for data estimation help derive costs from historical data.

Data estimations include average owning costs per square foot, average operating costs per square foot, project age, location, square footage, and stories.

The Whitehouse Research Facility Maintenance and Repair Cost Reference lists annualized OM&R for building systems and service life predictions for building parts.

If military construction is of interest, the Huntsville Division of the U.S. Army Corps of Engineers has a database for those types of OM&R.

Replacement Costs (‘Repl’)

The number and timing of capital replacements of building systems are determined by the system’s estimated life. Usually, the same sources that offer OM&R cost estimates are the same sources and also have some sort of replacement costs with their respective expected useful lives.

Using their costs as the base date is a good starting point for figuring out future replacement costs. LCCA will raise base year amounts to time of occurrence in the future.

Residual Values (‘Res’)

The value of a system is its remaining value. 

Residual value is the value in place, resale value, salvage value, or scrap value minus any cost of selling, cost of conversions, or disposal costs.

The residual value of a system with a remaining useful life can be calculated linearly with its initial costs to something as shown below:

For example, let’s say: There is a system with an expected use life of 20 years, installed 6 years before the end of the study period.

Other Costs (‘O’)

Any items that aren’t any other bucket end up here.

Finance Charges and Taxes: Finance charges are usually irrelevant for federal projects. However, finance charges, interest, and amortization fall under this category. 

Financing charges are up to the lender if it’s a non-government lender. If it is done through some sort of government program, there will usually be negotiations into contract payments with the Energy Service Company.

Non-monetary benefits or costs: Non-monetary benefits or costs are simply project-related effects that cannot be quantified. Unquantifiable items might include historical significance, a desirable zip code, and aesthetics.

Since non-monetary benefits or costs are unquantifiable, the analytical hierarchy process (AHP) is the standard procedure to evaluate both qualitative and quantitative attributes into an AHP score that reflects the project's overall desirability.

An example AHP matrix looks like this below: 

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Asset Valuation
• Asymmetric Information
• Business Life Cycle
• Capital Budgeting Best Practices
• Capital Gains Tax