life cycle costing

Life Cycle Cost Life Cycle Cost AnalysisAnalysis

Life Cycle Cost (LCC)Life Cycle Cost (LCC)

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

22


By using LCC, total cost of the product can be calculated over the total span of product life cycle.

33


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.

44

LCC for product supplierLCC for product supplier

By using LCC, product suppliers By using LCC, product suppliers can optimize their design by can optimize their design by evaluation of alternatives and by evaluation of alternatives and by performing trade-off studies.performing trade-off studies.

By using LCC, product suppliers By using LCC, product suppliers can evaluate various operating can evaluate various operating and maintenance cost strategies and maintenance cost strategies ((to assist product users).to assist product users).

55

LCC for customerLCC for customer

By using LCC, customers can By using LCC, customers can evaluate and evaluate and compare compare alternative productsalternative products..

By using LCC, customers can By using LCC, customers can assess assess economic viability economic viability of of projects or products.projects or products.

66

Why use LCC?Why use LCC?Typical conflict in most of the company: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.

77

Why use LCC?Why use LCC?

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

88

Why use LCC?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!!!

99

Cost elementCost element

For an equipment, there are TWO cost elements:

1) Initial Cost, and2) Operation & Maintenance

Cost

The identification of cost elements and their sub-division are based on the purpose and scope of the LCC study.

1010


Initial Cost:Initial Cost:– Design & development cost,Design & development cost,– Investment on asset, or cost of Investment on asset, or cost of

equipment,equipment,– Installation cost or erection & Installation cost or erection &

commission cost.commission cost.

1111


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

1212

Computation Computation ofof

Life Cycle Cost Life Cycle Cost AnalysisAnalysis

(Steps for LCCA)(Steps for LCCA)

Steps for computation of Steps for computation of LCCLCC

Step 1: Determine Step 1: Determine timetime for each cost for each cost element,element,

Step 2: Estimate Step 2: Estimate valuevalue of each cost of each cost element, element,

Step 3: Calculate Step 3: Calculate Net Present Value Net Present Value of of each element, for every year (over its each element, for every year (over its time period),time period),

Step 4: Calculate Step 4: Calculate LCCLCC by adding all by adding all cost element, at every year,cost element, at every year,

Step 5: Step 5: AnalyzeAnalyze the results. the results. 1414

Step 1: Determination of : Determination of timetime

– Determination of life cycle of the Determination of life cycle of the product (i.e. equipment, in this product (i.e. equipment, in this case).case).This Life cycle is not similar to This Life cycle is not similar to conventional conventional concept of Product Life Cycleconcept of Product Life Cycle. . Conventional concept of Product Life Cycle Conventional concept of Product Life Cycle implies to the time span based on demand implies to the time span based on demand of the product in the market, starting from of the product in the market, starting from launch of the product up to the time when launch of the product up to the time when company withdraw the product from the company withdraw the product from the market. That is purely a marketing concept.market. That is purely a marketing concept.

To be continued……

1515


– In LCC analysis of an equipment, life In LCC analysis of an equipment, life cycle means the life of the product that is cycle means the life of the product that is installed in the plant, i.e. installed in the plant, i.e. productive life productive life time time of the product.of the product.

– The product supplier provides the life The product supplier provides the life cycle depending on design calculation cycle depending on design calculation and experience.and experience.

– Based on supplier’s data, customer Based on supplier’s data, customer decides the Life Cycledecides the Life Cycle, i.e. how long he/ , i.e. how long he/ she wants to use the machine. Customer she wants to use the machine. Customer considers the effect of available considers the effect of available maintenance facility, technological maintenance facility, technological obsolescence and economic uncertainty obsolescence and economic uncertainty factor, also.factor, also. To be

continued……

1616


– After that, After that, company decides the company decides the time span for each componenttime span for each component..

– Example, say, a company decides Example, say, a company decides that total life cycle of the product that total life cycle of the product will be 10 years from the allocation will be 10 years from the allocation the fund, among which first one the fund, among which first one year will be initial cost zone and year will be initial cost zone and remaining 9 years will be under remaining 9 years will be under operation and maintenance cost operation and maintenance cost zone.zone.

1717

Step 2: Estimation of value: Estimation of value– Estimate monetary value for each Estimate monetary value for each

cost element.cost element.– This estimated value will be incurred This estimated value will be incurred

in every year. in every year. This value is basically This value is basically future income/cost at each year, future income/cost at each year, which is estimatedwhich is estimated..

– To estimate the value, various source To estimate the value, various source can be used; e.g. calculation based can be used; e.g. calculation based on facts and experience, MIS report on facts and experience, MIS report for similar existing machines, etc.for similar existing machines, etc.

1818

Step 3: Net Present Value: Net Present Value

– Money has a time value.Money has a time value.– The present value of future income The present value of future income

or future cost can be calculated by or future cost can be calculated by using using discounting factor discounting factor and and inflation factorinflation factor..


1919


Discount factorDiscount factor– The The discount ratediscount rate is an interest rate, a is an interest rate, a

central bank charges banking central bank charges banking institutions that borrow reserves from it.institutions that borrow reserves from it.

– For example, let's say Mr. Ram expects Rs. For example, let's say Mr. Ram expects Rs. 1,000 in one year's time. To determine the 1,000 in one year's time. To determine the present value of this Rs. 1,000 Ram would present value of this Rs. 1,000 Ram would need to discount it by a particular rate of need to discount it by a particular rate of interest (often the risk-free rate but not interest (often the risk-free rate but not always). Assuming a discount rate of always). Assuming a discount rate of 10%, the Rs. 1,000 in a year's time would 10%, the Rs. 1,000 in a year's time would be equivalent of Rs. 909.09 to Ram today (i.e. be equivalent of Rs. 909.09 to Ram today (i.e. 1000/[1+0.10]).1000/[1+0.10]). To be

continued……

2020


Inflation factorInflation factor– The The inflation rate inflation rate is the percentage is the percentage

by which prices of goods and by which prices of goods and services rise beyond their average services rise beyond their average levels. It is the rate by which the levels. It is the rate by which the purchasing power of the people in a purchasing power of the people in a particular geography has declined in particular geography has declined in a specified period.a specified period.


2121

Step 3: Net Present Value: Net Present Value Formula for Net Present Value (NPV)Formula for Net Present Value (NPV)

C (1+i/100) C (1+i/100) (n-1)(n-1)

PV= -----------------------PV= -----------------------

(1+d/100) (1+d/100) nn

where,where,

C = any cost element at nC = any cost element at nthth year year

I = inflation rateI = inflation rate

d = discount rate/ interest rated = discount rate/ interest rate 2222

Step 4: Summation of PVs: Summation of PVs PVs of each cost elements is PVs of each cost elements is

calculated for an equipment (at every calculated for an equipment (at every year).year).

PVs of each cost element in a year are PVs of each cost element in a year are added.added.

The process is done for every year The process is done for every year over the life cycle, i.e. LCC is over the life cycle, i.e. LCC is calculated for every year.calculated for every year.

2323

Step 5: Analysis: Analysis The data collected from LCC are analyzed.The data collected from LCC are analyzed. If one product has to be selected among If one product has to be selected among

multiple equipments, then LCC is multiple equipments, then LCC is calculated for every product.calculated for every product.

Data for every product are analyzed, and Data for every product are analyzed, and the the lowest LCC option lowest LCC option becomebecome preferredpreferred..

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.

2424

An important reminder…..

LCC provides critical information to the overall decision-making process, but not the final answer.

2525

Estimation Estimation of of

Life Cycle CostLife Cycle CostWith a typical case study!With a typical case study!

Case StudyCase Study

A highly productive foundry shop has A highly productive foundry shop has one sophisticated robot operated core one sophisticated robot operated core making machine (made in Italy).making machine (made in Italy).

Due to increase of demand for its Due to increase of demand for its casting, the foundry shop wants to casting, the foundry shop wants to install one new core making machine.install one new core making machine.

For new machine, there are two options:For new machine, there are two options:1.1. Similar sophisticated robotic machine, orSimilar sophisticated robotic machine, or2.2. Semi-automated machine. Semi-automated machine.

2727

Option 1Option 1 Initial costInitial cost

Sl. Sl. NoNo..

Cost ElementCost Element Value Value (in (in

INR, INR, millionmillion)/ year)/ year

Time Time phasphas

ee

RemarksRemarks

11 Design & Design & development development (D)(D)

-- -- Bought Bought out itemout item

22 Investment on Investment on asset (A)asset (A)

59.459.4 0-1 0-1 yearyear

33 Installation (I)Installation (I) 0.60.6 0-1 0-1 yearyear

1% of 1% of asset costasset cost

2828

Option 1Option 1 Initial cost (IC)Initial cost (IC)Computation of PV of ICComputation of PV of IC

D(1+i/100) D(1+i/100) (n-1)(n-1) A(1+i/100) A(1+i/100) (n-1)(n-1) I(1+i/100) I(1+i/100) (n-1) (n-1)

PV= ------------------------ + ---------------------- + -----------------------PV= ------------------------ + ---------------------- + ----------------------- (1+d/100) (1+d/100) nn (1+d/100) (1+d/100) nn (1+d/100) (1+d/100) nn

n is the year on which PV will be calculated, here n=1 year, onlyn is the year on which PV will be calculated, here n=1 year, only

Interest rate, d=8%Interest rate, d=8%Inflation rate, i=5%Inflation rate, i=5%

0(1+5/100) 0(1+5/100) 00 59.4(1+5/100) 59.4(1+5/100) 00 0.6(1+5/100) 0.6(1+5/100) 0 0

PV= ----------------------- + ------------------------ + ---------------------PV= ----------------------- + ------------------------ + --------------------- (1+8/100) (1+8/100) 11 (1+8/100) (1+8/100) 11 (1+8/100) (1+8/100) 11

From calculation, From calculation, PV of IC = 55.5 million PV of IC = 55.5 million INRINR 2929

Option 1Option 1 Operation & Maintenance CostOperation & Maintenance Cost

Sl. Sl. NoNo..

Cost ElementCost Element ValueValue (in INR, (in INR, million)/ million)/

yearyear

Time Time phasephase

RemarksRemarks

11 Labour (L)Labour (L) 0.30.3 2-10 2-10 yearyear

4 workers 4 workers @ 3 shifts@ 3 shifts

22 Energy (E)Energy (E) 44 2-10 2-10 yearyear

MIS report MIS report of existing of existing equipment, equipment, as new as new equipment equipment is identicalis identical

33 Spare & Spare & maintenance (S)maintenance (S)

2.62.6 2-10 2-10 yearyear

44 Raw material (M)Raw material (M) 27.727.7 2-10 2-10 yearyear 3030

Option 1Option 1 Operation & Maintenance cost (OC)Operation & Maintenance cost (OC)Computation of PV of OCComputation of PV of OCTotal OC= L+E+S+M=34.6 Million INRTotal OC= L+E+S+M=34.6 Million INRPV of OC at nPV of OC at nthth year, year,

OC(1+i/100) OC(1+i/100) (n-1)(n-1)

PV= ------------------------PV= ------------------------ (1+d/100) (1+d/100) nn

Cumulative value of OC after nCumulative value of OC after nthth year (in terms year (in terms of PV)of PV) OC(1+i/100) OC(1+i/100) (n-1)(n-1)

= = ƩƩ ------------------------ ------------------------ (1+d/100) (1+d/100) nn

PV of OC and cumulative OC at different year PV of OC and cumulative OC at different year to be calculated by using this formulato be calculated by using this formula.. 3131

Option 1Option 1 COMPUTATION OF LCC: TABLE 1COMPUTATION OF LCC: TABLE 1

Operation & Maintenance cost (OC)

Initial Cost (IC) Total LCC

Time Period

Discounting factor

Inflation factor

Future OC at nth

yearPV of any

yearTotal PV incurred

nth year 1/(1+8/100)n (1+5/100)n-1

Million INR Million INR Million INR

Million INR Million INR

A B C D E=DXBXCF=E+ last 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 55.50 306.613232

Option 1Option 1

Computation of LCCComputation of LCC

In the previous calculation, expected In the previous calculation, expected future values of OC at all the years future values of OC at all the years were same, i.e. 34.6 Million INR.were same, i.e. 34.6 Million INR.

This expected value can be different This expected value can be different for different years, too.for different years, too.

3333

Option 2Option 2

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

3434

Option 2Option 2 COMPUTATION OF LCC: TABLE 2COMPUTATION OF LCC: TABLE 2

Operation & Maintenance cost (OC)

Initial Cost (IC) Total LCC

Time Period

Discounting factor

Inflation factor

Future OC at

nth yearPV of any

yearTotal PV incurred

nth year 1/(1+8/100)n (1+5/100)n-1

Million INR Million INR Million INR

Million INR Million INR

A B C D E=DXBXCF=E+ last 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 42.00 404.883535

AnalysisAnalysisLife Cycle Cost Analysis

0

50

100

150

200

250

300

350

400

450

1 2 3 4 5 6 7 8 9 10

Time (Year)

LC

C (I

NR

, in

Mill

ion

)

Option 1:Robotic M/c

Option 2:Semi-Auto M/c

3636

AnalysisAnalysis

The analysis shows:The analysis shows:– initial cost of semi-automated machine initial cost of semi-automated machine

is lower.is lower.– But, the long term LCC is much lower for But, the long term LCC is much lower for

Robotic machine.Robotic machine. Considering LCCA, Considering LCCA, the robotic the robotic

machine is preferred compared to machine is preferred compared to the semi-automated machinethe semi-automated machine, , for for this particular application.this particular application.

3737

Capital Budgeting & LCCCapital Budgeting & LCC

LCC is one of the important tool for LCC is one of the important tool for capital budgeting.capital budgeting.

LCC is one of the useful tool which LCC is one of the useful tool which enables investors to analyze enables investors to analyze investment in terms of economic investment in terms of economic behaviour.behaviour.

3838

Documents

life cycle costing