Life Cycle Cost Analysis Life Cycle Cost LCC

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 tradeoff 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.

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

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!!!

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 subdivision are based on the purpose and scope of the LCC study.

Cost element Initial 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 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. 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 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]). 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 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

Step 4: Summation of 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.

Step 5: Analysis The datas collected from LCC 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!

Case Study 1. 2. 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.

Option 1 Initial cost Sl. No. Cost Element 1 Design & development (D) 2 3 Value Time (in INR, phase million)/ year Remarks - - Bought out item Investment on asset (A) 59. 4 0 -1 year Installation (I) 0. 6 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 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) 0 PV= ------------ + ---------- (1+8/100) 1 From calculation, PV of IC = 55. 5 million INR

Option 1 Operation & Maintenance Cost Sl. No. Cost Element Value (in Time phase Remarks INR, million)/ year 1 Labour (L) 0. 3 2 -10 year 4 workers @ 3 shifts 2 Energy (E) 4 2 -10 year 3 Spare & maintenance (S) 2. 6 2 -10 year 4 Raw material (M) 27. 7 2 -10 year MIS report of existing equipment, as new equipment is identical

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.

Option 1 COMPUTATION OF LCC: TABLE 1 Operation & Maintenance cost (OC) Time Period Discounting factor Inflation factor Future OC at nth year 1/(1+8/100)n (1+5/100)n-1 Million INR PV of any year Total PV incurred Initial Cost (IC) Total LCC Million INR G H=G+F A B C D E=DXBXC F=E+ last year's F 1 - - - 55. 50 2 0. 86 1. 05 34. 60 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. 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.

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 Inflation factor Future OC at nth year 1/(1+8/100)n (1+5/100)n-1 Million INR PV of any year Total PV incurred Initial Cost (IC) Total LCC Million INR G H=G+F A B C D E=DXBXC F=E+ last year's F 1 - - - 42. 00 2 0. 86 1. 05 50. 00 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

Analysis

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.

Capital Budgeting & LCC is one of the important tool for 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.