Life Cycle Cost Analysis

Life Cycle Cost (LCC)

 Lifecycle costing, LCC, is the
accumulation of costs for activities
that occur over the entire life cycle of
a product, from inception to
abandonment including its cost of
installation, operation, maintenance,
conversion, and/or decommission.

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 Life Cycle Cost (LCC)
 Byusing LCC, total cost of the
product can be calculated over the
total span of product life cycle.

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 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.

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 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).
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 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.

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 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,
 Accounting wants to maximize project net
present value as the only criteria,
 Shareholders want to increase stockholder
wealth as the only criteria.

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

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 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!!!

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 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.

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

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 Cost element
 Operation & Maintenance Cost:
– Labour cost,
– Energy cost,
– Spare & maintenance cost,
– Raw material cost.

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 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.
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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.
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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 supplier’s 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. 16
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.
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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/cost 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.
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 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.

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To be continued……
 Step 3: Net Present Value
 Discount factor
– The discount rate is an interest rate, a
central bank charges banking institutions
that borrow reserves from it.
– For example, let's say Mr. Ram expects Rs. 1,000
in one 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%, the Rs. 1,000 in a year's
time would be equivalent of Rs. 909.09 to Ram
today (i.e. 1000/[1+0.10]). 20
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.

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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 22
 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.

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 Step 5: Analysis
 The data collected from LCC are analyzed.
 If one product has to be selected among
multiple equipments, then LCC is calculated
for every product.
 Data 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. 24
 An important reminder…..

LCC provides critical information to the

overall decision-making process, but not
the final answer.

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 Estimation
of
Life Cycle Cost
With a typical case study!
 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:
1. Similar sophisticated robotic machine, or
2. Semi-automated machine.
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 Option 1
 Initial cost
Sl. Cost Element Value Time Remarks
No. (in INR, phase
million)/
year
1 Design & - - Bought out
development (D) item
2 Investment on 59.4 0-1
asset (A) year
3 Installation (I) 0.6 0-1 1% of
year asset cost
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 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 0.6(1+5/100) 0
PV= ----------------------- + ------------------------ + ---------------------
(1+8/100) 1 (1+8/100) 1 (1+8/100) 1

From calculation, PV of IC = 55.5 million INR

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 Option 1
 Operation & Maintenance Cost
Sl. Cost Element Value Time Remarks
No. (in INR, phase
million)/
year
1 Labour (L) 0.3 2-10 4 workers @
year 3 shifts
2 Energy (E) 4 2-10 MIS report of
year existing
equipment,
3 Spare & 2.6 2-10
as new
maintenance (S) year
equipment is
4 Raw material (M) 27.7 2-10 identical
year 30
 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)
= Ʃ ------------------------
(1+d/100) n
PV of OC and cumulative OC at different year to be
calculated by using this formula.
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 Option 1
 COMPUTATION OF LCC: TABLE 1
Operation & Maintenance cost (OC)
Future
Time Discounting Inflation OC at nth PV of any Total PV Initial
Period factor factor year year incurred Cost (IC) Total LCC
nth Million Million
year 1/(1+8/100) n
(1+5/100) n-1
INR Million INR Million INR INR Million INR
F=E+ last
A B C D E=DXBXC year's F G H=G+F
1 - - - - - 55.50 55.50
2 0.86 1.05 34.60 31.15 31.15 55.50 86.65
3 0.79 1.10 34.60 30.28 61.43 55.50 116.93
4 0.74 1.16 34.60 29.44 90.87 55.50 146.37
5 0.68 1.22 34.60 28.62 119.49 55.50 174.99
6 0.63 1.28 34.60 27.83 147.32 55.50 202.82
7 0.58 1.34 34.60 27.05 174.38 55.50 229.88
8 0.54 1.41 34.60 26.30 200.68 55.50 256.18
9 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 32
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.

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 Option 2
 Different cost element for option 2 (i.e.
Semi-automated machine) has been
estimated and final calculation for LCC has
been done.

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 Option 2
 COMPUTATION OF LCC: TABLE 2
Operation & Maintenance cost (OC)
Future
Time Discounting Inflation OC at PV of any Total PV Initial
Period factor factor nth year year incurred Cost (IC) Total LCC
nth Million Million
year 1/(1+8/100) n
(1+5/100) n-1
INR Million INR Million INR INR Million INR
F=E+ last
A B C D E=DXBXC year's F G H=G+F
1 - - - - - 42.00 42.00
2 0.86 1.05 50.00 45.01 45.01 42.00 87.01
3 0.79 1.10 50.00 43.76 88.77 42.00 130.77
4 0.74 1.16 50.00 42.54 131.31 42.00 173.31
5 0.68 1.22 50.00 41.36 172.68 42.00 214.68
6 0.63 1.28 50.00 40.21 212.89 42.00 254.89
7 0.58 1.34 50.00 39.10 251.99 42.00 293.99
8 0.54 1.41 50.00 38.01 290.00 42.00 332.00
9 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
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 Analysis
Life Cycle Cost Analysis

450
400 Option 1:
350 Robotic M/c
LCC (INR, in Million)

300
250
200 Option 2:
Semi-Auto M/c
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Time (Year)
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 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.

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 Capital Budgeting & LCC
 LCC is one of the important tool for capital
budgeting.
 LCC is one of the useful tool which
enables investors to analyze investment in
terms of economic behaviour.

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