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Uni
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Riverso, Milo Edilio

A LIFE CYCLE COST SYSTEM FOR VALUE ENGINEERING IN BUILDING


DESIGN AND CONSTRUCTION

Purdue U niversity Ph.D. 1984

University
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University
Microfilm s
International
J? ;

A LIFE CYCLE COST SYSTEM FOR VALUE ENGINEERING

IN BUILDING DESIGN AND CONSTRUCTION

A Thesis

Submitted to the Faculty

of

Purdue U niversity

by

Milo Edilio Riverso

In Partial Fulfillm ent of the

Requirements for the Degree

of

Doctor of Philosophy

August 1984
G ra d . School
Form No. 9
Revised

PURDUE UNIVERSITY

Graduate School

This is to certify that the th e sis prepared

gy Milo Edilio R i v e r s o _______________________________________________________

Entitled ^ L ife Cycle Cost System f o r Value E n g in e e rin g in

___________ B u i l d i n g Design And C o n s t r u c t i o n

C om plies with the U n iversity regulations and that it m eets the accepted
standards o f the Graduate School with resp ect to origin ality and quality

For the d egree of:

Doctor of Philosophy

Signed by the final examining^ci ittee

, chairm an

Approved by the head of school or department:

^____ 19 £*4 —P

To the librarian:
is
This thesig^ls n o t \o be regarded as confidential

P r o fe s so r in charge o f the th e sis


ii

The a u t h o r wishes to dedicate this thesis to his

mother, father, and grandparents, for the love, support,

leadership, and d i s c i p l i n e they have alw ays made a v a i l a b l e .

f
iii

ACKNOWLEDGEMENTS

The a u t h o r would like to express his sincere gratitude

to his major professor, Dr. Do n e E. Hancher, for encourage­

me n t and guidance in this research effort, and in the

author's graduate studies.

He w o u l d also l i k e to convey his sincere appreciation

to the other members of the committee fo r their comments and

suggestions .

In addition, he w o u l d like to thank all his undergradu­

ate and graduate professors, who h e l p e d instruct and prepare

the author for these endeavors.

Special thanks are given t o Miss D i x i e Elaine To p p for

her diligent assistance in preparing this thesis.


iv

«
TABLE OF CONTENTS

Page

LIST OF TABLES ........................................................................................................ viii

LIST OF FIGURES ..................................................................................................... xi

LIST OF ABBREVIATIONS ANDNOMENCLATURE ............................................. xiv

ABSTRACT .......................................................................................................................... xx

CHAPTER 1 - INTRODUCTION .................................................................................. 1

1.1 S t a t e m e n t of P u r p o s e ........................................................................ 2
1.2 Scope of t h e L i f e C y c l e C o s t S y s t e m ............................... 3

CHAPTER 2 - VALUEENGINEERING ........................................................................ 6

2.1 I n t r o d u c t i o n ............................................................................................. 6
2 . 1 . 1 V a l u e ........................................................................................ 7
« 2.1.2 Value E ngineering ................................................... 10
2 . 1 . 3 V a l u e E n g i n e e r i n g S t u d y Te a ms ........................... 12
2 . 1 . 4 Ti me F r a m e ........................................................................... 14
2.2 J o b P l a n ........................................................................................................ 17
2.2.1 I n f o r m a t i o n P h a s e ........ .................................................... 20
2 . 2 . 2 S p e c u l a t i o n Phase ................................................... 37
2 . 2 . 3 A n a l y s i s P h a s e ................................................................ 42
2 . 2 . 4 Development Phase ................................................... 53
2 . 2 . 5 P r e s e n t a t i o n P h a s e ..................................................... 56
2.3 H i s t o r y a nd B a c k g r o u n d ..................................................... 58

CHAPTER 3 - VALUE ENGINEERING WITHIN THE CONSTRUCTION


INDUSTRY ............................................................................................ 65

3.1 I n t r o d u c t i o n ........................................................................................... 65
3 .2 The S u r v e y ................................................................................................ 66
3.2.1 O b j e c t i v e s of t h e S u r v e y ...................................... 66
3 . 2 . 2 The S u r v e y I n s t r u m e n t .......................................... 70
3 . 2 . 3 D a t a b a s e ................................. 71
3.3 S u r v e y R e s u l t s ...................... 73
3.4 Summar y a n d C o n c l u s i o n s ............................................................. 110

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Page

CHAPTER 4 - ALTERNATIVE METHODS OF ECONOMIC ANALYSIS


AND CAPITAL BUDGETING ......................................................... 112

4.1 I n t r o d u c t i o n ................................................................... 112


4.1.1 A f t e r - T a x C a s h F l o w s .......................................... 113
4.1.2 C a p i t a l R a t i o n i n g and D e c i s i o n M a k in g . 119
4.2 D i s c o u n t R a t e ..................................................................................... 122
4.2.1 W e i g h t e d A v e r a g e C o s t o f C a p i t a l .......... 123
4.2.2 P u b l i c F i n a n c e .......................................................... 130
4.3 N o n - L i f e C y c l e C o s t i n g M e t h o d s .................... 131
4.3.1 S im ple and D i s c o u n t e d Payback P e r i o d . 132
4.3.2 B e n e f i t - C o s t R a t i o ................................................ 133
4.3.3 A c c o u n t i n g R a t e o f R e t u r n ............................ 137
4.4 L i f e C y c l e C o s t i n g M e t h o d s ................................................ 139
4.4.1 N e t P r e s e n t V a l u e A n a l y s i s .......................... 140
4.4.2 E q u i v a l e n t Uniform Annual Value
A n a l y s i s ............................................................................ 143
4.4.3 D i s c o u n t e d Rate of R e t u r n A n a l y s i s . . . 147
4.4.4 N e t P r e s e n t V a l u e A n a l y s i s v s . R a t e of
R e t u r n .................................................................................. 148
4.5 O t h e r E c o n o m i c T o p i c s ....................................................... 153
4.5.1 I n f l a t i o n a n d E s c a l a t i o n E f f e c t s .......... 155
4.5.2 O t h e r Ta x C o n s i d e r a t i o n s ................................ 162
4.5.3 E c o n o m i c E v a l u a t i o n P e r i o d .......................... 163
4.5.4 I n t e g e r and L i n e a r Programming
A p p l i c a t i o n s .................................................................. 165
4.5.5 L o n g Term C a p i t a l B u d g e t i n g ....................... 168
4 . 6 ........................... C o n c l u s i o n .................................................................. 170

CHAPTER 5 - LI FE CYCLE COSTING WITHINVALUE ENGI NEERING. 171

5 . 1 .............................I n t r o d u c t i o n ................................................................... 171


5.1.1 D e v e l o p m e n t of L i f e C y c l e C o s t i n g
W i t h i n V a l u e E n g i n e e r i n g ................................. 172
5 . 2 I m p o r t a n c e o f L i f e C y c l e C o s t s ........................................... 174
5.2.1 S i g n i f i c a n c e o f L i f e C y c l e C o s t s .......... 176
5.2.2 I d e n t i f i c a t i o n of L i f e C y c l e C o s t s . . . 179
5.3 C u rren t Prominent L ife Cycle Costing
P r o c e d u r e s ............................................................................................... 180
5.3.1 S o c i e t y of Am erican Value E n g i n e e r s . . . 182
5.3.2 N a t i o n a l B u r e a u o f S t a n d a r d s ..................... 183
5.3.3 O t h e r O r g a n i z a t i o n s ............................................. 184

CHAPTER 6 - THE ESTIMATING LINK ..................................................... 186

6.1 E s t i m a t i n g S y s t e m I n t e r a c t i o n ............................................ 186


6.2 C o n s t r u c t i o n C o s t C o d i n g ................................................... 191
6.2.1 T h e M a s t e r f o r m a t ..................................................... 193
6.2.2 Th e U n i f o r m a t .............................................................. 197
6.2.3 I n d u s t r y A c c e p t a n c e and D e v e l o p m e n t s . 201
6.2.4 H i e r a r c h y o f C o s t Co d e s .................................. 204
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Page

6.3 Requirements of a Life Cycle Costing System ... 205

CHAPTER 7 - PROPOSED LI FE CYCLE COST SYSTEM .............................. 209

7.1 S y s t e m D e s c r i p t i o n ..................................................................... 209


7.1.1 H i g h C o s t B u i l d i n g S y s t e m s .......................... 215
7.1.2 S y s t e m F l e x i b i l i t y ................................................ 2 1 7
7.1.3 I m p l e m e n t a t i o n T e c h n i q u e s ............................. 219
7.2 L i f e C y c l e C o s t E s t i m a t i n g ..................................................... 2 2 2
7.2.1 L i f e C y c l e C o s t I d e n t i f i c a t i o n ............... 226
7.2.2 F o r m a t and O r g a n i z a t i o n of E s t i m a t e . . 229
7.3 S o u r c e o f D a t a ........................................................................................' 2 3 2
7.4 C u r r e n t D a t a b a s e s A v a i l a b l e .................................................. 237
7.5 R e q u i r e m e n t s o f a L i f e C y c l e C o s t D a t a b a s e . . . . 247

CHAPTER 8 - PROPOSED LI FE CYCLE COST DATABASE


DEVELOPMENT ................................................................................ 248

8.1 L i f e C y c l e C o s t D a t a b a s e P r e f a c e ..................................... 248


8.2 D a t a D e v e l o p m e n t .................... . ........................................................ 255
8.2.1 A c c o u n t i n g M e t h o d ................................................... 255
8.2.2 E n g i n e e r e d M e t h o d ................................................... 258
8.2.3 A ccounting v s . E n g in e e r e d Data
Development ................................................. 261
8.3 D a t a A d j u s t m e n t ................................................................................... 263

CHAPTER 9 - UNCERTAINTY OF LI FE CYCLE COST ESTIMATES ... 268

9.1 U n c e r t a i n t y .............................................................................................. 268


9.2 Me thods of D e s c r i b i n g U n c e r t a i n t y ................................ 270
9.2.1 S e n s i t i v i t y A n a l y s i s M e t h o d ........................ 271
9.2.2 R a n g e E s t i m a t e M e t h o d ........................................ 273
9.2.3 E x p e c t e d V a l u e M e t h o d ........................................ 275
9.2.4 M o n t e C a r l o S i m u l a t i o n M e t h o d .................. 280
9.3 M e t h o d s o f D e a l i n g W i t h U n c e r t a i n t y ............................. 282

CHAPTER 10 - PROMULGATION OF VALUE ENGINEERING WITHIN


THE CONSTRUCTION INDUSTRY ..................................... 285

10.1 The B u i l d i n g Team ....................................................................... 286


10.1.1 The Owner ...................... 286
10.1.2 The A r c h i t e c t / E n g i n e e r ................................. 289
10.1.3 The C o n s t r u c t o r ..................................................... 292
10.2 New A p p l i c a t i o n s o f V a l u e E n g i n e e r i n g ...................... 294

CHAPTER 11 - SUMMARY AND RECOMMENDATIONS ...................................... 296

11.1 Summa r y ................................................................................................... 29 6


11.2 R e c o m m e n d a t i o n s f o r F u t u r e R e s e a r c h ........................... 298

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Page

LITERATURE CITED ......................................................................................................... 301

BIBLIOGRAPHY .................................................................................................................... 309

APPENDICES

Appendix A : Value E n g i n e e r i n g Su rv e y Document . . . . 317


Appendix B : U n i f o r m a t B u i l d i n g D e s c r i p t o r s .................. 324
Appendix C : U n i f o r m a t H i e r a r c h y E x a m p l e .......................... 333

VI TA .......................................................................................................................................... 338

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f
LIST OF TABLES

Table Page

3.1 Questionnaire Response R a t e ......... ...................................................... 74

3.2 Summar y t o S u r v e y Q u e s t i o n ; P r e v i o u s to th e
B r i e f D e f i n i t i o n s of V a l u e E n g i n e e r i n g a n d V a l u e
I n c e n t i v e C l a u s e s , Had You Known Wha t VE a n d / o r
VIC Was? ............................................................................................................. 75

3.3 Summar y t o S u r v e y Q u e s t i o n ; Has Y o u r O r g a n i z a t i o n


E v e r S u b m i t t e d a n d / o r Be e n I n v o l v e d I n t h e
S u b m i s s i o n of An A l t e r n a t i v e D e s i g n U n d e r a
- V a l u e I n c e n t i v e C l a u s e ? ................................... 78

3.4 Summar y t o S u r v e y Q u e s t i o n ; Do You F e e l Y o u r


O r g a n i z a t i o n ' s E x p e r ie n c e With Value E n g i n e e r in g
I n c e n t i v e C l a u s e s A r e ? ....................................................................... 80

3.5 Summar y t o S u r v e y Q u e s t i o n ; H a s Y o u r O r g a n i z a t i o n
E v e r B e e n I n v o l v e d I n a " P u r e " (By t h e
D e f i n i t i o n ) "Value E n g i n e e r i n g " Study for a
C o n s t r u c t i o n P r o j e c t ? ......................................................................... 82

3.6 Summar y t o S u r v e y Q u e s t i o n ; I f Yo u r O r g a n i z a t i o n
Has B e e n I n v o l v e d i n " P u r e " Value E n g in eerin g
S t u d i e s , When Was t h e S t u d y P e r f o r m e d ? ............................. 84

3.7 Summar y t o S u r v e y Q u e s t i o n ; I f Yo u r O r g a n i z a t i o n
Has B e e n I n v o l v e d i n " P u r e " V a l u e E n g i n e e r i n g
S t u d i e s , Di d T h e y P r o v e To Be P r o d u c t i v e ( We r e
S a v i n g s G r e a t e r Th a n C o s t s ) F o r t h e Owne r ? .................. 85

3.8 Summar y t o S u r v e y Q u e s t i o n ; I f Yo u r O r g a n i z a t i o n
Has B e e n I n v o l v e d I n " P u r e " V a l u e E n g i n e e r i n g
S t u d i e s , What Do You E s t i m a t e Y o u r A v e r a g e
S a v i n g s t o C o s t R a t i o To Be? ........................................................ 87

3.9 Summar y t o S u r v e y Q u e s t i o n ; P l e a s e I d e n t i f y t h e
S o u r c e o f C o n t r a c t s W i t h W h i c h Yo u r O r g a n i z a t i o n
Has B e e n I n v o l v e d W i t h V a l u e E n g i n e e r i n g a n d / o r
Value I n c e n t i v e C la u ses W ithin the C o n s t r u c t i o n
I n d u s t r y ............................................................................................................... 88

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Table Page
€ 3.10 Summar y to Survey Q u e s t io n ; P l e a s e I d e n t i f y the
Ty p e o f Work W i t h W h i c h Y o u r O r g a n i z a t i o n Has
Be e n I n v o l v e d W i t h V a l u e E n g i n e e r i n g a n d / o r
Value I n c e n t i v e C la u s e s W ithin th e C o n s t r u c t i o n
I n d u s t r y ................................................................................................................ 89

3.11 Summar y to Su rv e y Q u e s t i o n ; P l e a s e I d e n t i f y t h e
Type o f C o n t r a c t s W i t h Which Your O r g a n i z a t i o n
Has B e e n I n v o l v e d W i t h V a l u e E n g i n e e r i n g a n d / o r
Value I n c e n t i v e C la u s e s W ithin th e C o n s t r u c t i o n
I n d u s t r y ............................................................................................................... 90

3.12 Summar y t o S u r v e y Q u e s t i o n ; Wo u l d You L i k e t o


Se e V a l u e I n c e n t i v e C l a u s e s o r V a l u e E n g i n e e r i n g
S t u d i e s B e i n g Us e d Mo r e O f t e n i n t h e F u t u r e ? ........... 92
3.13 Summar y t o S u r v e y Q u e s t i o n ; What I s t h e Mi n i mu m
S i z e C o n s t r u c t i o n P r o j e c t You F e e l Wo u l d B e n e f i t
Fr om t h e I m p l e m e n t a t i o n o f V a l u e I n c e n t i v e
C l a u s e s ? ................................................................... 93

3.14 Summar y t o S u r v e y Q u e s t i o n ; What I s t h e Mi n i mu m


S i z e C o n s t r u c t i o n P r o j e c t You F e e l Woul d B e n e f i t
Fr om t h e I m p l e m e n t a t i o n o f V a l u e E n g i n e e r i n g
S t u d i e s ? ............................................................................................................. 94
€ 3.15 Summar y t o S u r v e y Q u e s t i o n ; Woul d Your
O r g a n i z a t i o n be I n t e r e s t e d i n L e a r n i n g M o r e A b o u t
Value E n g in e e r in g and i t s A p p l i c a t i o n s W ith in the
C o n s t r u c t i o n I n d u s t r y ? ....................................................................... 100

3.16 Summar y t o S u r v e y Q u e s t i o n ; I n Wha t Ways Wo u l d


Yo u r O r g a n i z a t i o n b e I n t e r e s t e d i n L e a r n i n g Mo r e
A b o u t V a l u e E n g i n e e r i n g ? ................................................................. 102

3.17 Summar y t o S u r v e y Q u e s t i o n ; Doe s Yo u r


O r g a n i z a t i o n Use a C o n s t r u c t i o n C o s t F o r m a t ? ........... 105

3.18 Summar y t o S u r v e y Q u e s t i o n ; What Type o f a


C o n s t r u c t i o n F o r m a t Does Y o u r O r g a n i z a t i o n Use? .. 106

3.19 Summar y t o S u r v e y Q u e s t i o n ; Wo u l d Your


O r g a n i z a t i o n be I n t e r e s t e d i n L e a r n i n g Mo r e A b o u t
T h e s e Two C o n s t r u c t i o n F o r m a t s ? ............................................... 107

4.1 After-Tax C a s h F l o w Summa r y ........................................................... 115

4.2 Ti me D i s p a r i t y Example ......................................................................... 150

4.3 A Summar y o f Inflation And E s c a l a t i o n E ffects .... 156


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Table Page

5.1 Total Cost of OwnershipI l l u s t r a t i o n ...................................... 175

6.1 Expected Accuracy of E s t i m a t e s ................................................... 190

6.2 Uniformat Levels 1 & 2 ............................................................. 200

9.1 Example System .............................................................................................. 270

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xi


LIST OF FIGURES

Figure Page

2.1 R e l a t i v e I n f l u e n c e s o f P r o j e c t D e c i s i o n s on
L i f e C y c l e C o s t s ......................................................................................... 15

2.2 The F i v e Step Job P l a n ........................................................................... 18

2.3 C o s t Model Based in Uniformat ........................................................ 25

2.4 C o s t Model Based on M a s t e r f o r m a t ................................................ 26

2.5 Relationship between Uniformat and M a s t e r f o r m a t ... 27

2.6 Ground R u l e s f o r F u n c t i o n a l A n a l y s i s S ystem s


T e c h n i q u e ( FAST) D i a g r a m ............................................. 33

2.7 Conceptual FAST D i a g r a m Example .................................................. 35

^ 2.8 FAST D i a g r a m f o r Sidewalk Network ............................................ 36

2.9 M orphological Analysis Example ................... 41

2.10 Feasibility Ranking Form ..................................................................... 44

2.11 TRB's Life Cycle Cost D istribution .......................................... 48

2.12 Life Cycle Cost A n a l y s is For m ........................................................ 50

2.13 C riteria Weighing Form ........................................................................... 51

2.14 Analysis M atrix For m ............................................................ 54

2.15 Army C o r p s o f E n g i n e e r s V a l u e E n g i n e e r i n g
Summa r y o f S a v i n g s .................................................................................... 63

4.1 Incremental Rate of Return Analysis ..................................... 149

4.2 Ti me D i s p a r i t y Explanation ............................................................. 152

4.3 Summarization of Econo mic Decision Making ..................... 154

4.4 A Typical Rent Adjustment Clause ............................................. 160

5.1 Significance of an A n n u i t y ............................................................. 177

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Figure Page
M
5.2 Significance of a Future Amount ...................... - ..................... 178

5.3 D ell'Iso la 's Life Cycle Costs ..................................................... 181

6.1 Construction Project Timeline ..................................................... 188

6.2 Developing a Project Code F r o m a Standard Code .. 193

6.3 Masterformat List of Divisions .................................................. 195

6.4 M asterformat Broadscope Level Example ........................... 195

6.5 Example of M a s t e r f o r m a t Breakdown .......................................... 196

6.6 M a s t e r f o r m a t Method of C lassification ........................... 197

6.7 Example of Uniformat Levels 2, 3, & 4B r e a k d o w n .. 201

6.8 Uniformat Nomenclature ........................................................................ 202

7.1 Proposed Life Cycle Cost System ............................................... 210

7.2 Example of Owner's C riteria & P ro fileChecklist .. 211

7.3 Building System C o s ts .................................................................... 218

^ 7.4 Example of the Life Cycle C o s t Model ................................. 221

7.5 Possible Foundation Wall A l t e r n a t i v e s .................................... 223

7.6 Life Cycle Cost Identification .................................................. 227

7.7 Life Cycle Cost Estim ate Form ..................................................... 231

7.8 D e ll'Iso la 's and K i r k ' s LCC D a t a b a s e .......... ............................ 239

7.9 List of Life Cycle Cost Sources ................................................ 241

8.1 1 9 8 1 - 1 9 8 2 B u i l d i n g M a i n t e n a n c e T r a d e Wage
I n f o r m a t i o n ..................................................................................................... 254

8.2 Construction Productivity E fficiency Factors ............. 266

9.1 Sensitivity Family Curves ................................................................ 272

9.2 Sensitivity Percent Variance Curves ..................................... 274

9.3 Range Estimate Example ........................................................................ 276

9.4 Expected Value Method Example ..................................................... 279

f
xii i

Figure Page

10.1 Methods of P r o c u r i n g Construction Services ................. 288


xi v

LIST OF A B B R EVI AT ION S AND NOMENCLATURE

t h e a f t e r - t a x d i s c o u n t r a t e u s e d by t h e m a r k e t to
evaluate a l e v e l a n n u a l income s t r e a m of the s o r t
g e n e r a t e d by f i r m s i n t h i s r i s k c l a s s .

1- a the confidence coefficient.

A an e n d - o f - p e r i o d c a s h r e c e i p t or disbursement in a
uniform annual s e r i e s .

ACRS A ccelerated Cost Recovery System.

AGC Associated General Contractors.

AIA American Institute of A r c h i t e c t s .

ASHRAE American Society of Heating and R efrigeration


Engi nee r s .

ASTM American Society of Testing and M a t e r i a l s .

b t h e p e r c e n t a g e ga p between the theoretical and


a c t u a l p r o c e e d s r e a l i z e d wh e n new s t o c k i s i s s u e d .

B the book v a l u ^ o f t h e fixed asset at the time of


s a l e in the n year.

V' t h e book v a l u e
t i l l n '.
of the item being replaced if kept

V t h e book v a l u e
present y ear.
of the item being replaced in the

BLAST Building Loads Analysis and Systems Thermodynamics


program.

BOMA Buildings Owners and Managers A ssociation,

c the average investment for the alternative,

c the outlay of the j*"*1 p r o j e c t in period a.


aj
XV

t tl
c. the outlay required on t h e j project in period
J t .
o
C cost.

C t h e maxi mum a m o u n t t o be s p e n t on c a p i t a l invest-


0 m ent s i n p e r i o d t Q.

CERL Army C o r p s o f Engineers Construction Engineering


R e s e a r c h Lab, a t Champaign, I l l i n o i s .

CSC C onstruction Specifications of Canada.

CSI C onstruction Specifications Institute.

CVS C ertified Value Specialist.

d^ the dividends per share payment or earnings per


share in year i.

d^ the current y ear's per share dividend.

d the dividend per share payment or earnings per


0 share in a s e le c te d base year.

D t h e t o t a l a m o u n t of l o n g t e r m d e b t o f the organi­
za tio n , expressed in current d o lla rs.

D the d e p re c ia tio n in year t of the proposed invest­


ment .

D ' the d e p r e c i a t i o n i n y e a r t of t h e o l d d e p r e c i a b l e
asset to b e r e p l a c e d by p r o p o s e d c a p i t a l i n v e s t ­
ment.

DOE-II a energy load c a l c u l a t i o n s program developed by


t h e D e p a r t m e n t of E n e r g y .

ENR Engineering News R e c o r d .

EPS Engineered performance standards.

EUAB the equivalent annual benefit of a proposal.

EUAC the equivalent annual cost of a proposal.

F the fu tu re value, at the end of year n, ofa cash


f low.

F' t h e f u t u r e amount of t h e benefits or costsin an


in flatio n ary period.
xvi

FAST Functional Analysis Systems Technique.

g a historical annual growth rate for an organiza­


tion.

GSA/ PBS General Services A dm inistration/Public Building


Service.

h the desired half-w idth of the confidence interval.

H the t o t a l annual cost for the basic condition or


exis ting one.

the total cost for a proposed improvement.

i the discount rate.

i t h e number of y e a r s between the selected base year


and the y e a r i .

an e s c a l a t e d discount rate.

a nominal discount rate.

a real discount rate.

an index which models a specific environment.


€ the i n i t i a l capital expenditure for the invest­
ment .

ES Illum ination Engineers Society.

J a set of m utually exclusive projects.

K th e growth a d j u s t e d d i v id e n d y i e l d or the d i s c o u n t
rate which an i n v e s t o r would d e r i v e from f u t u r e
r e t u r n s o f an i n v e s t m e n t .

X the applicable income tax rate.

X the applicable tax rate on capital gains and


assets.

LCC Life Cycle Costing.

MARR mi n i mu m a t t r a c t i v e rate of return.

n the needed sample size for each building sample.

n the number of years the cash flow is being


dis counted.
xvii

n is the 'e x p e c t e d economic life of the item to be


replaced.

N the total number of y e a r s of the analysis .

NBS N ational Bureau of Standards

NEUAW equivalent uniform annual worth,

NPV net present value,

NPW net present worth.

NPW the a d ju s te d net p r e s e n t worth of a p r o j e c t which


a
incorporates a different reinvestm ent discount
rate.
k U

NPW the net present worth of the j project.


j
0 the working capital required for the investment.
c
0 the cash outlays n ecessitated by the investm ent
e
th a t are e x p e n s e d on t h e b o o k s .

P the total number of projects.

P present value.

P the c u rre n t market price being traded for the


o
o rg a n iz a tio n 's stock.

the present v a l u e of benefits.


PVb
PV the p r e s e n t v a l u e of costs.
c
PERT Project Evaluation and Review T e c h n i q u e .

PM preventive m aintenance.

V an a d j u s t m e n t factor.

r the c u r r e n t a n n u al interest rate for the borrowing


of long term d e b t .

the annual r a t e of escalation of a cost item,


above or below the g e n e r a l a n n u a l r a t e of infla­
tion.

the general annual rate of inflation.


th
a reinvestm ent rate of funds released in the t
year .
xviii

the t o t a l annual user cost for the basic condi­


tion.

th e cash g e n e ra te d b e fo r e taxes by a d d e d revenues


or reduced o u t l a y s .

the to ta l annual user cost for a proposed improve­


ment .

the weighted average cost of capital.

the cost of c a p i t a l f o r the long term debt.

the cost of c a p i t a l f o r the e q u ity .

the cost of c a p i t a l f o r the r e t a i n e d e a r n i n g s .

roof square feet.

t h e p l a n n e d s t a n d a r d d e v i a t i o n of the entire popu­


l a t i o n of t h e b u i l d i n g s y s t e m s .

the standard deviation ( ot ) of the distribution.


e
t h e n e t c a |j i r e a l i z e d from the sale of the fixed
a s s e t in n year.

the salvage value of ' t h e item being replaced if


kept t i l l n ' .

the s a l v a g e v a l u e of the item being replaced in


the present year.

the salvage value.

Society of American Value E n g in e e rs.

the year in which working capital is required.

the year in which working capital is released.

the optim istic value.

the pessim istic value.

the corporate income tax rate of the organization,

the most likely estim ate.

the proper capital gains tax rate for the


o rg an iz atio n 's stock owners.
xix

t the mo s t likely value,


m
t the personal income tax rate for the
^ o rg an izatio n 's sto c k owners.

TRB Transportation Research Board.

y the mean v a l u e (t ).
e
UCI Uniform C o n s t r u c t i o n Index.

US United States.

V value.

V the current market value of the o rg an izatio n 's


s tock.
VE Value Engineering.

VEIC Value E ngineering Incentive Clause.

VIC Value Incentive Clause.

W worth.

W o t h e r c a s h o u t l a y s n e c e s s i t a t e d by t h e i n v e s t m e n t
t h a t a r e n o t t r e a t e d as p a r t of t h e a s s e t a c q u i r e d
a n d a r e n o t e x p e n s e d on t h e b o o k s .

W , t h e funds f r e e d from wo|Jting c a p i t a l in year t (in


t h i s c a s e t h e l a s t or n year).

XR the percentage of the o rg an izatio n 's capital


s t r u c t u r e which i s r e t a i n e d e a r n i n g s .

Xq the percentage of the o rganization's capital


s t r u c t u r e which i s long term d e b t .

Xg the percentage of the organization's capital


s t r u c t u r e which is e q u i t y .

z a normal random g e n e r a t e d number.


ABSTRACT

R i v e r s o , Milo E d i l i o . P h . D . , P u r d u e U n i v e r s i t y , Au gu st 1984.
A Life Cycle C o st System f o r Value E n g i n e e r i n g in B u i l d i n g
Design and C o n s t r u c t i o n . Major P r o f e s s o r : Donn E. H a n c h e r .

Th e usage of Value Engineering has become a growing

trend within both the design and construction phases of the

C onstruction Industry. Value Engineering is a method used

to facilitate the increase in the life cycle value of a pro­

ject. It has rapidly gained acceptance in several govern­

ment agencies which procure construction services. However,

Value Engineering is currently receiving a slower acceptance

in private in dustry's procurement of construction services.

This study, presented herein, evaluates the use of

Value Engineering in several integral parts of the Construc­

tion Industry. Th e s t u d y examines areas of discontent with

Value Engineering and proposes methods which, if imple­

mented, should alleviate those problem atic areas. The study

presents a Life Cycle Cost system which may be used for the

evaluation and comparison of designs and construction

methods during the original d e s ig n work or during applica­

tions of Value Engineering. In addition, the study presents


a s y ste m which may be u s e d for the collection and organiza­

tion of life cycle cost data for building systems. The

implementation of such a system would enhance the use of

Value Engineering by i n c r e a s i n g the accuracy of the Life

Cycle Costing decisions made w i t h i n the Value Engineering

studies.
1

CHAPTER 1

INTRODUCTION

Value Engineering was introduced into the Construction

Industry in the early t o mi d 1960's. Since that time it has

developed into a very prominent system used to improve the

value of construction projects. To d a t e , the academic world

has partaken in the development and promulgation of Value'

Engineering w ithin the Construction Industry on a v e r y minor

level. The e v e r expanding use of Value Engineering w ithin

the Construction Industry can be a t t r i b u t e d to its own m e r ­

its.

The Construction Industry is the largest non-

agricultural industry within the United States. Annual

expenditures w ithin the Construction Industry w ill approach

the t wo h u n d r e d billion dollar level in the near future. [1]

It singly has mor e influence on mo r e related industries than

any other industry w ithin the T.’ i t e d States. For these rea­

sons, any tool which could encourage mo r e efficient con­

struction would have far-reaching effects throughout the

entire economy of the United States. Value Engineering is


such a tool; it can elim inate unnecessary costs in the

design and methods of construction which have plagued the

Construction Industry since the beginning of time.

The m o s t significant and noteworthy attribute associ­

ated with Value Engineering is the system atic method in

which it applies various and diverse tools. The system atic

job plan makes use of complex theories and tools developed

in remarkably different fields, ranging from financial

economics, to creative psychology, to industrial engineer­

ing. The V a l u e Engineering methodology combines and u til­

izes many diversified tools, developed by these different

fields of research, in a unique and powerful amalgamation

with the sole intended purpose of increasing the value of a

project or product for the owner.

Statement of Purpose

The p u r p o s e of this thesis is twofold. The initial

purpose is to examine the unique method in which the metho­

dology of Value Engineering is applied w ithin the Construc­

tion Industry, and to present methods which can improve its

use and nurture its growth w i t h in the Construction Industry.

The second purpose is to present a life cycle cost system

that w ill aid in the use of Value Engineering w ithin the

C onstruction Industry. Th e system w ill be s p e c i f i c a l l y

developed to meet the requirements of the building construc­

tion area, although, with minor adaptations and


m odifications, it should be a p p l i c a b l e to the heavy & high­

way construction and industrial construction areas. The

development of the life cycle cost system w i l l include the

design of a compatible life cycle cost database.

O ther key objectives of the thesis include a discussion

of the proper life cycle costs required by the system, a

discussion of alternate economic methods of analysis, the

development of a probabilistic model for life cycle costs,

and the presentation of the results of a study to determine

the level of knowledge and u s e of Value Engineering which

currently exists in t h e C onstruction Industry. In addition,

the thesis w ill present an e v a l u a t i o n of existing life cycle

costing data and recommendations on f u t u r e life cycle infor­

mation that should be investigated for extending the benefi­

cial use of the life cycle co^t system w ithin Value

Engineering and ordinary design methods for the Construction

Indus t ry .

J_. 2_ Scope of the Life Cycle Cost System

Since the Value Engineering methodology utilizes many

tools, its ultim ate success becomes dependent on the full

performance of these tools. The entire methodology w ill

only be a s laudable as each of the individual tools which it

employs. If o ne of the tools employed by the Value

Engineering methodology f a i l s to operate at the optimum

level, then the entire system w i l l fail to produce an


optimum y i e l d . As w i l l be explained later, life cycle cost­

ing is an e x a m p l e of one of the tools utilized in the Value

Engineering methodology. If a m iscalculation or e r r o r is

made in calculating the life cycle costs of the alterna­

tives, then the risk of making an e r r o r in the final choice

becomes highly probable.

The s u c c e s s of Value Engineering within the Construc­

tion Industry is dependent upon the development of a v a l i d

system to evaluate the life cycle costs involved in con­

struction. The estim ation of the life cycle costs of a con­

struction project need to be a c c u r a t e , precise, consistent

and valid in order to choose between mutually exclusive

design alternatives and c o n s t r u c t i o n methods.

The basic requirem ents of a life cycle cost system and

database are as follow s:

1. Th e system and database w ill need to be easily

integrated with common cost coding systems used in

design, construction, and post-construction operation

and m a i n t e n a n c e systems.

2. Th e database w ill need to classify costs in a quality

category. Common maintenance of a building can vary

quite distinctively.

3. Th e s y s t e m and database will need to be stratified into

several levels of detail so that it may be u s e d during


5

initial and final design and construction phases.

4. Th e d a t a b a s e should not be e a s i l y dated by economical

factors, such as inflation.

5. The s y s t e m w i l l need to account for time frames (useful

lives) and other future plans of the owner of the

facility .

Without the fulfillm ent of these basic requirem ents, a

life cycle cost analysis would result in a less than optimum

decision. Such a decision would lead to a loss of credibil­

ity and confidence in the Value Engineering methodology.


6

CHAPTER 2

VALUE ENGINEERING

2^1_ I n t r o d u c t i o n

T raditionally, the Construction Industry has been

plagued by spiraling costs as a result of inflation,

resource shortages, the fulfillm ent of labor demands, and

other economic and political factors. Although inflation

seems to have been reduced to a mi n i mu m in the present

economic clim ate, analysis of inflation trends demonstrates

that inflation is unstable and cyclical in nature, having

periods of sharp increases in addition to periods of slow

decreases. One can expect that double digit inflation w ill

be experienced once again in the future. Moreover, energy

costs have proven to be e v e n mo r e unstable, being affected

not only by normal inflation rates, but also by r e s o u r c e

shortages and geopolitical, tensions throughout the world.

Although the problem atic costs of oil and other fossil

fuels, as w e l l as other energy resources have been tem­

porarily alleviated, one can expect eventual escalation in

the price of these energy resources as the dwindling sup­

plies begin to disappear. As a result of rising costs,


7

construction projects are being canceled or submitted to

arbitrary cost cutting analysis due to lim ited financing and

budgetary constraints.

Everyone involved in the development of ne w construc­

tion projects should feel compelled and professionally obli-

gated to strive for and seek out efficient methods of reduc­

ing initial costs and life cycle costs. A system atic method

of reducing the initial and life cycle costs of a construc­

tion project would produce a surplus of funds which could b.e

used to fund additional projects that ordinarily would be

turned down due to lack of funding, or to fund additional

preventive maintenance on e x i s t i n g structures.

Value Engineering is a proven management technique

using a system atic approach to seek out the best functional

cost, reliability, and performance of a project. The pro­

gram seeks to promote progressive change by i d e n t i f y i n g and

removing unnecessary costs without sacrificing the original

function of a project. [ 2]

2.1.1 Value

Before one can fully comprehend the theory of Value

Engineering methodology, he must master the meaning of the

term "value". The term "value" can be very ambiguous in

its meaning to different people with different basic


backgrounds. W ebster's New World Dictionary defines the

term "value" in the following ways:

"1. A f a i r e q u iv a len t in money, etc. for something


s o ld or exchanged. 2. The w o r t h of a t h i n g i n mo ne y o r
goods at a c e r t a i n tim e . 3. Estimated or appraised
worth. 4. Purchasing power. 5. Th a t q u a l i t y of a
t h i n g a c c o r d i n g t o w h i c h i t i s t h o u g h t o f a s b e i n g mor e
or l e s s d e s i r a b l e , u s e f u l , e t c . " [3]

When d e f i n i n g value w ithin the Construction Industry,

one is prim arily dealing with monetary values. Although, as

w ill be shown later, he can use certain tools, such as cri­


teria m atrixes, to quantifiably take into consideration

non-monetary values. Two e x a m p l e s of non-monetary values

are aesthetic value and monumental or h i s t o r i c a l value. For

example, let us say a decision wa s being made with respect

to the exterior wall finish for a library on the Indiana

U niversity Bloomington Campus. Consider that the alterna­

tives for the exterior wall finish are Indiana lim estone a nd

common red brick. Although common red b r i c k might be less

expensive, one must consider that the entire Indiana

U n iv ersity 's Bloomington campus is composed of limestone

buildings. Therefore, the decision process which is to be

used in choosing an e x t e r i o r wall finish for the library

must quantifiably consider the monetary value, the aesthetic

value, and the monumental or historical value associated

with each of the alternatives.

However, since the assignment of non-monetary values

are subjective in nature, these values do n o t enter the


decision analysis until the latter phase of the decision

process. Value can be d e f i n e d as the lowest cost that will

satisfactorily and reliably provide the critical functions

consistent with the optimum c o s t s of ownership. [ 4] Equation

2.1 shows value as being proportional to the worth to cost

ratio of an i t e m .

V = -H_ (2.1)

Whe r e V s t a n d s for the value of the item, C stands for the

cost of the item, and W s t a n d s for the worth of the item.

One a c h i e v e s a perfect value whe n cost is equal to worth and

the value is equal to one. This is an ideal value and acts

as the goal which a designer or constructor strives to

achieve. When t h e worth is less than the cost of the item,

the value is less than one and therefore less than optimum.

Less frequently experienced, if the worth of an i t e m is

greater then the cost, the value would be greater than one

a nd therefore would be o p t i m a l . Although an e s t i m a t e of the

cost of an item is readily attainable through the use of bid

quotations and estim ating tools, an e s t i m a t e of the worth of

an i t e m is n o t . as easily achieved. One method of determ in­

ing the worth of an i t e m w o u l d be to artfully compare the

production costs of substitutes for the constituents of the

item which prove to be a d e q u a t e and c o m p e t i t i v e . [5]

Alphonse D ell'Iso la, an e x p e r i e n c e d value engineer in

the Construction Industry, defines worth as "the lowest cost

to p e r f o r m the basic functions and the required secondary


10

functions in the most elementary manner feasible, w ithin the

state of our present technology". [6] His method of deter­

mining worth relies upon the m anipulation of historical

costs of sim ilar items wh ic h would satisfy the basic func­

tions of the item being studied. [ 7]

A value engineer or designer has a professional commit­

ment or goal to seek the highest (optimum) value or to

improve the value of a project. There are three methods

which can be employed to achieve this goal of optim ality.


First, by d e c r e a s i n g the cost of an i t e m while keeping the

worth of the item constant. Second, by i n c r e a s i n g the worth

of an i t e m while keeping the cost of the item constant.

Lastly, through a combination of decreasing the cost while

increasing the worth of the item. These three methods can

be readily perceived by m a n i p u l a t i n g equation 2.1.

2.1.2 Value Engineering

Value Engineering is a management tool used to provide

the best value of a project or product to the owner. It is

used in the Construction Industry to provide a review of the

design and construction methods employed for a project dur­

ing both the design and construction phases of the project.

It is a system atic method of elim inating unnecessary costs

for a project, thereby increasing the value of the project

for the owner.

«
The V a l u e Engineering methodology can be a p p l i e d to a

construction project during the design, construction, and

operation phases of the project. There are two forms of

applying the Value Engineering methodology in the Construc­

tion Industry. First, through the use of Value Engineering

studies which can be p e r f o r m e d throughout the design, con­

struction, and operation phases. Second, through the use of

Value Incentive Clauses which can be i n c l u d e d in construc­

tion contracts and in operation and m aintenance contracts

employed throughout the entire life of the building. The

specific times during the life of a p r o j e c t in which these

t wo forms of Value Engineering should be applied, in order

to optimize their productive use, w ill be discussed in the

latter part of this section.

Value Engineering differs from traditional cost cutting

techniques in several ways. Two of the wa ys in which it

deviates from these cost cutting techniques are worth not­

ing. First, Value Engineering is not a random c o s t - a x i n g

method, but utilizes a system atic methodological job plan.

Second, Value Engineering considers the values and functions

of the project. T raditional cost cutting techniques might

just consider the initial construction costs of a project,

where Value Engineering considers the functions of the pro­

ject and a t t e m p t s to reduce the costs of the project without

sacrificing any of the required functions. Th e method in

which these t wo a d v a n t a g e s of Val ue Engineering are achieved


12

w ill be discussed at length in the latter part of this

chapter.

The s u c c e s s of a Value Engineering study is measured by

comparing the cost of the study and implementation costs to

the estim ated benefits which would be realized if the pro­

posed alternatives generated by the Value Engineering study

were implemented. Implementation costs include those costs

required to successfully implement an alternative. For

example, any further development costs required to make the


proposed alternative into a reality or any redesign costs

which result from t h e decision to go a h e a d with an alterna­

tive are examples of implementation costs. To p e r f o r m the

proper comparison, these costs and benefits should be

expressed in terms of equivalent dollars through the use of

present value techniques. These techniques w ill be dis­

cussed further in latter portions of this chapter and in

future chapters.

Onc e the savings and c o s t s of an a l t e r n a t i v e have been

determined, a savings to cost ratio is computed. This ratio

is the major me a n s the owner has of judging both the success

and the efficiency of the Value Engineering study.

2.1.3 Value Engineering Study Te a ms

Value Engineering studies are generally performed dur­

ing the design phase of a construction project. A Value

f
Engineering team is organized consisting of three or mo r e

members; the actual number of m e m b e r s depends upon several

variables, such as the size of the project and the amount of

time which is allotted for the study. In certain cases, the

project may be very large or very complex, requiring several

Value Engineering teams to perform the study. In these

cases the project is divided into separate fragments and

each team is assigned a specific fragment to study. A Value

Engineering team c o n s i s t i n g of several members of the build­

ing team (owners,' architects, engineers, construction

managers, construction contractors, vendors, suppliers,

maintenance personnel, and the u s e r ) is contacted and organ­

ized by an e x p e r i e n c e d V a l u e E n g i n e e r who i s designated as

the team leader. The team should be composed of very

diverse members of thebuildin-g team, since the Value

Engineering methodology ma k e s v a lu a b le use of this diver­

sity. For example, if a process plant m echanical engineer

is included on a V a l u e Engineering study team for a building

construction project, he might be a b l e to p ro v id e s o me very

valuable input on how his division of t h e industry might

handle a design which might be a p p l i c a b l e to the building

division of the industry. In addition to diversity, the

study team s h o u l d have at least one person well versed in

cost estim ating methods, since a large portion of the Value

Engineering methodology utilizes cost estim ating. Although

this requirement could be satisfied by having a cost

engineering consultant available, it would be a distinct


advantage having first hand experience as part of the team.

In order to properly use Value Engineering, the members

of this team s h o u l d have i n no way b e e n involved or associ­

ated with the design of the project being studied. If

members were involved with the original design, they might

be biased toward that design, which would not allow them to

deviate from it. This would act as a roadblock to the

creative process involved in Value Engineering, which is

relied upon to generate alternate designs and construction


methods. In addition, the Value Engineering team should

separate themselves from the normal everyday routines and

problems to prevent untimely interruptions. Most Value

Engineering studies should be e x e c u t e d w ithin a lim ited time

span in order to minimize costs and increase the efficiency

of the study.

2.1.4 Ti me F r a me

The t i m e at which Value Engineering studies should be

performed on a p r o j e c t requires a subjective decision. Fig­

ure 2.1 displays the time and c o s t tradeoff relationship for

the decision m aker's influence on t h e life cycle costs of a

project. [8] As s h o w n i n Figure 2.1, the decision m aker's

greatest influence on t h e costs of a project is during the

time the project is in the design phase, although the con­

tractor still had a recognizable portion of influence on t h e

costs of the project during the construction phase.


15

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ii

L
I
User Agency
F
Standards Criteria
E
c
Y
C
L Designer
E
c
o
s Initial
T Contractor
s Operations &
Maintenance
Personnel

TIME

Figure 2.1 Relative Influences of P r o j e c t Decisions on


L i f e Cycle C osts
However, the optimal time to elim inate or reduce unnecessary

costs using Value E n g i n e e r i n g studies is during the initial

conceptual and design phases of the project.

Th e m a i n controversy involved in the tim ing of the

Value Engineering study is in determ ining at which point

during the design phase the study should be performed. If

performed too early in the design phase, prior to twenty

percent design completion, the amount of inform ation avail­

able is insufficient to perform a Value Engineering study.

If performed too late in the design phase, following eighty

percent design completion, the risk of costs of project

redesign and delays proving greater than potentiaj. savings

exists. Therefore, a lack of inform ation and cost of

redesign tradeoff e x i s t s . The time at which the study is

performed is largely a subjective decision, and dependent

upon the specific project involved.

Z i mme r ma n a n d H a r t , t wo e x p e r i e n c e d value engineers in

the C onstruction Industry, propose the idea of t wo V a l u e

Engineering studies for a p r o j e c t . The first study, per­

formed early in the design and p l a n n i n g phase, would study

the conceptual and o v e r v i e w ideas and design criteria of the

project. The s e c o n d study, performed in the latter part of

the design phase, would study the detail construction ele­

ments of the project. [ 9] This two-step approach, proposed

by Zi mme r ma n a n d H a r t , isa unique method of handling the

lack of inform ation and cost of redesign tradeoff discussed


17

earlier, allowing one to study the p ro ject's design require­

ments and criteria at a time wh e n they may b e amended easily

and yield beneficial cost savings. In a d d itio n , this method

allows review of detailed construction m aterials chosen

within the preordained criteria, at a time wh e n t h e r e exists

enough inform ation to perform the proper study and y i e l d

substantial cost savings.

2_-2_ Job Plan

As m e n t i o n e d previously, the system atic job plan is a

noteworthy credit to the Value Engineering methodology. The

job plan is a system atized, step by s t e p procedure, which is

utilized by the Value Engineering study team t h r o u g h o u t the

course of the study. Various job plans exist. There are

five-phase, six-phase, seven-phase, and eight-phase job

plans which are available to the Value Engineering study

team. B asically, these job plans are very sim ilar, differ­

ing only in the addition of certain phases which act as

refinem ents to the basic five phase job plan. Figure 2.2

displays the most c o mm o n l y used basic five phase Value

Engineering job plan. [10] The job p la n serves as a sys­

tem atic vehicle in acco m p lish in g the goals of the Value

Engineering study. Although a strict adherence to the five,

six, seven, or eight phase job plan is not required, the

Value Engineering team should follow the general order of

ensuing phases proposed by o n e of these plans.

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18

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Following is a listing of the phases included in a

basic five step Value Engineering job plan:

1) Inform ation Phase

2) Speculative Phase

3) Analysis Phase

4) Development Phase

5) Presentation Phase

As m e n t i o n e d above, the order in which the phases are

entered should attempt to assim ilate the order in which they

are listed above, although the Value Engineering study team

can reverse itself and return to a prior step if needed.

For example, it is not u n c o mmo n that a team which has

already entered the analysis phase might require additional

inform ation to properly complete an economic comparison

among alternatives. In this case, the team would need to

briefly return to the inform ation phase in order to collect

additional needed inform ation.

As discussed earlier, the five phase job plan is not

the only job plan available to a Value Engineering study

team. The f i n a l decision of which job plan w ill be u t i l i z e d

in the study is usually left up to the team leader. The

seven phase job plan consists of the s a me five phases of the

basic job plan, with the addition of an i m p l e m e n t a t i o n phase

and a f o l l o w up p h a s e . A team l e a d e r might decide to employ

the seven phase job plan if the additional t wo p h a s e s would


provide additional helpful output for the owner, and if the

owner expresses the w illingness to supply the additional

funds necessary to perform these t wo p h a s e s . For example,

if the owner is a one time investor and does not expect to

invest in any future projects, the probability is very high

that the owner w oul d n o t be i n t e r e s t e d in a follow up study,

since the actual results of the Value Engineering study

would be superfluous inform ation for him. However, if the

owner is a regular investor in new c o n s t r u c t i o n projects, it


is likely that he would express an i n t e r e s t in a follow up

study in order to determine if it would be p r o f i t a b l e to

have additional Value Engineering stu d ie s performed on

future projects.

Many tools and procedures are employed by the Value

Engineering methodology. Each of the tools have specific

applications, and are associated with a particular phase of

the job plan. It is not w ithin the scope of this report to

discuss each a nd e v e r y tool which might have an application

in a Value Engineering study. Hence, only the principal

tools which are of major significance to the Value Engineer­

ing methodology w ill be examined.

2.2.1 Information Phase

Ea c h of the five phases is mnemonicly named. During

the information phase, the Value E n g in e e r in g study team

gathers pertinent inform ation r e la te d to the project. The


21

objective of this phase is two fold. First, to provide an

inform ation base for the study which w ill aid the study team

during each of the phases of the job plan. Second, to

select specific areas of the project at which to aim the

thrust of the Value Engineering study. [11] In a d d i t i o n , it

is at this point of the job plan that the Value Engineering

methodology introduces a very powerful tool called function

analysis. Cost modeling is a second tool which has

widespread applications w ithin the inform ation phase.

Through the implementation of these t wo t o o l s , decisions are

ma d e which will direct the future course taken by the Value

Engineering team.

The inform ation phase begins with the collection of all

available pertinent data for the project d e v e l o p e d up to

that point in the design. Documents such as owner's

requirem ent, owner's criteria, prelim inary drawings, work

drawings, specifications, planning estim ates, conceptual

estim ates, etc. are amassed. This transfer of inform ation

could be done in a prestudy m eeting. An o w n e r ' s representa­

tive, a d esigner's representative, and the entire Value

Engineering team s h o u l d be present. Such a meeting would

lead to an examination of what the owner's needs are as

opposed to the owner's wants. For example, an o w n e r ' s need

might be a request for the design of a m o n u m e n t a l building.

However, if the owner includes a request for a specific

m aterial, such as granite or lim estone, as part of his


22

design criteria, it would be c l a s s i f i e d as an o w n e r ' s want.

If the Value Engineering team i s restricted by o w n e r ' s wants

rather than owner's needs, it would place far too rigid lim ­

itations on available options which the Value E n g i n e e r i n g

team co u ld investigate. These lim itations would ultim ately

result in the inclusion of u n n e c e s s a r y costs which would

undermine the goals of the Value Engineering study. In

addition, the prestudy meeting would allow the Value

Engineering team to question the p ro je c t's architect with


regard to certain design assumptions and s p e c i f i c design

strategies wh ic h went into the project planning up to that

point in the design development.

It is during the inform ation phase that the assemblage

of a database of inform ation is undertaken. This database

consists of all inform ation which the team feels w ill be

needed at s ome point in time throughout the job plan. This

information may c o n s i s t of conceptual and detailed cost

estim ating manuals, m anufacturer's fact sheets, design manu­

als, inform ation on new t e c h n o l o g i c a l advances in the field,

a list of available consultants, suppliers, experts, etc..

If this inform ation is gathered during the inform ation

phase, it w ill alleviate a major portion of the problem of

being forced to return to the inform ation phase w hile in the

m idst of performing in one of the other phases of the job

plan as mentioned in Section 2.2.


Value Engineering studies performed at the earlier con­

ceptual design phases examine the overview concept. How­

ever, if Value Engineering studies examining the conceptual

design are performed in the l a t t e r stages of the design

phase, they run the risk of having the implementation costs

exceed the estim ated benefits which would be generated if

the proposed alternatives were implemented. Therefore,

Value Engineering studies performed in the latter stages of

the design c o mm o n l y examine more detailed design aspects.

Moreover, a decision has t o be made to determine which

aspects, if not all, should be studied in order to maximize

the yield of benefits. In o t h e r words, which aspects of the

building harbor the most u n n e c e s s a r y costs and which, if

studied, would realize the greatest savings.

It is at this point that D ell'Iso la applies the princi­

ple expressed by P a r e t o ' s law. P areto's law m a n i f e s t s that

the bulk of the system cost w i l l be found in approxim ately

twenty percent of its components. When a p p l i e d to a con­

struction project, D ell'Iso la states that if a building is

broken down i n t o one hundred elem ents, twenty of those ele­

ments would a c c o u n t for an a p p r e c i a b l e amount of the total

cost, thereby accounting for an appreciable amount of the

unnecessary costs. [12] Wi t h this in mind, a cost model

should be prepared which partitions the building into

separate divisions. A cost model would enable the Value

Engineering study team to examine the most expensive items


in order to judge which items hold the largest savings

potent i a l .

Two common c o n s t r u c t i o n cost coding formats are pre­

valent in the Construction Industry today. The f i r s t ,

M asterform at, is a trade oriented format w h i c h wa s developed

by the Construction Specifications Institute. [13] The

second, Uniformat, is a building systems oriented format

w h i c h wa s developed jointly by t h e General Services Adminis­

tration and t h e American Institute of A rchitects. [14] As


w ill be s h o wn in Chapter Three, the M asterform at is, by a n d

large, the most widely used format between the two. How­

ever, as D ell'Iso la states, the Uniformat is recommended for

use in Value Engineering studies performed in the earlier

phases of the design, and the M asterformat should be

employed for Value Engineering studies performed as the pro­

ject approaches the bidding phase. These t wo formats w ill

be discussed further in Chapter Five. Figures 2.3 [15] and

2.4 [16] display cost models based on t h e Uniformat and the

Masterformat respectively. In Figure 2.5, a chart depicting

the relationship between the Uniformat and the Masterformat

c a n be found. [17] Computer programs exist which aid in the

exchange of inform ation between these t wo form ats. Although

these are the most c o mmo n l y used formats w ithin the building

Construction Industry, they are not required. Cost models

dependent on c o m p a n y developed cost coding formats may be

constructed. If the project involves the construction of a


Cost Model

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26

Cost Model
(UCI)
O f f ic e B u ild in g

T o ta l S ld g .

i___ _ J

G e n e ra l C o n s t. M e c h ./E le c .

_ J i___ ____ 1 I

S ite S tru c . A rch . M ech . E le c .

i__________ i i
C one. M a so n ry

-i_ i__________i
M e ta ls T h e rm .
& M o ist.

i__________ i I__________I
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l_________ J
O th e r

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Figure 2.4 Cost Mo d e l B a s e d on M a s t e r f o r m a t *

* R e p r i n t e d from "Value Engineering In The C o n s t r u c t i o n


Indus t r y " .

«
27

Z vt
s I

- al'.-s

Level l 3 5 J J J if o = ; r : 2 5 | I
'3 in (J 5 3 P a . tn uj u. tn CJ
Design •- cNcn^t nt af ^MOC —cNm^Lno Total
U niform at o o o o o o o c o — —— — — — — U n i f o r m a t Costs:
01 F oundations 011 S t a n d a r d F o u n d a t i o n s
012 Spec Foundation C ond
02 S ubstructure 021 S l a b O n G ra d e
02 2 B asem en t E x cavation
0 2 3 B a s e m e n t Walls
03 S uperstructure 031 F l o o r C o n s t r u c t i o n
03 2 R oof C onstruction
033 Stair Construction
04 Ext. C lo s u r e 041 E x t e r i o r Walls
0 4 2 E x t . O oors & W i n d o w s
0 5 R o o f in g
0 6 In t. C o n st. 061 P a r t i t i o n s
0 6 2 I n t e r i o r Fin ish e s
0 6 3 S p e c ia lt ie s
0 7 C o n v e y i n g Sys.

< 0 8 M e c h a n ic a l 081 Plum bing


0 8 2 H .V .A .C .
0 8 3 Fire Protection
0 8 4 S p e c . M e c h a n ic a l S y s t.
0 9 Ele ctrical 091 Se rv ic e & D i s t r i b u t .
0 9 2 L ig h tin g A n d P o w e r
0 9 3 S p e c . Electrical S y s t .
10 G e n C o n d . O H & P
11 Equipm ent 111 F i x e d & M o v a b le E q u i p
112 F u rn is h in g s
1 13 S p e c ia l C o n s t r u c t i o n
12 S i t e w o r k 121 S i t e P r e p a r a t i o n
122 S i t e I m p r o v e m e n t s
123 S i t e Utilities
124 O ff- S ite Work

Figure 2.5 R elationship between Uniformat and M a s t e r ­


format *

* R ep rin ted from "Value Engineering In The C o n s t r u c t i o n


I n d u s t r y ".
process plant, a m anufacturing line, or a highway, the Value

Engineering study team may find it worth their time to

develop an original cost model, since established ones do

not exist.

Onc e cost estim ates are developed for each division of

the cost model, the Value Engineering study team must

develop worth estim ates for each division using methods pre­

viously discussed. The cost-to-w orth ratios can t h e n be

computed. The s t u d y t e a m may choose which divisions the

team w ill examine using the cost-to-w orth ratios as a b a s i s

for their decisions. Obviously, a division with a high

cost-to-w orth ratio would imply a very large savings poten­

tial. If the divisions chosen are small enough, one Value

Engineering study team can perform the study by g o i n g

through the job plan for each of the divisions separately.

If the project is very large, the owner may w i s h to u t i l i z e

several Value E n g i n e e r i n g study teams, each to examine an

assigned division.

Thus far, cost models based upon initial construction

cost estim ates have been discussed. However, other models

may be u s e d as an a i d in determining the best divisions to

examine. For example, Zi mme r ma n a n d Hart are advocates of

using a life cycle cost model or an e n e r g y model for this

purpose. A life cycle cost model aids in determining which

divisions of the project w ill be responsible for the

greatest portions of the total cost of ownership over the


life of the building. An e n e r g y model acts as an aid in

determ ining which divisions of the project are responsible

for consuming the largest amounts of energy. [18] Therefore,

through the use of these two.models, a Value Engineering

study can be made to accommodate an o w n e r who is interested

in elim inating unnecessary life cycle costs as well as

unnecessary energy consumption.

Much o f the success of Value Engineering has been

attributed to its m anipulation of Function A nalysis. Func­


tion Analysis is devoted to seeking out the true owner's

needs as opposed to an o w n e r ' s wants. It forces the Value

Engineering study team to define the basic functions of the

item being studied. If the Value Engineering study team i s

examining the conceptual or overview design of a construc­

tion project, then a single Function Analysis on t h e total

project will suffice. However, as mentioned previously, if

the Value Engineering study examines separate divisions of

the project, a separate Function Analysis for each division

is warranted.

Function Analysis injects a higher level of credibility

into Value Engineering. It insures that a Value Engineering

study w ill not transgress into a traditional cost cutting

session. Lawrence D. M iles, the originator of the Value

Engineering methodology, states that Function Analysis "can

improve the thinking process, and ultim ate decision making".

[19] Function Analysis is a method used to sim plify the


30

description of the function of an i t e m . Through its use, a

greater latitude of alternative solutions may be explored.

Function Analysis is a method of defining the functions

and subfunctions of integral parts of the project being

investigated. It employs simple t wo o r three word descrip­

tions to define the function of an item, system, or project.

Arthur E. Mudge b e s t describes the rules of constructing

functional definitions as follows:

Rule #1: The e x p r e s s i o n o f a l l f u n c t i o n s m u s t be a c c o m ­


p l i s h e d i n t wo w o r d s , a verb and a noun.

Rule #2: The e x p r e s s i o n o f w o r k a n d s e l l f u n c t i o n s uses


d i f f e r e n t c a t e g o r i e s of v e r b s a n d n o u n s .

A. Work f u n c t i o n s a r e a l w a y s expressed
i n a c t i o n v e r b s and m e a s u r a b l e n o u n s
which e s t a b l i s h q u a n t i t a t i v e state­

< ments.

B. S e l l f u n c t i o n s are always expressed


in passive verbs and n o n m e a s u ra b le
nouns which establish qualitative
statem ents.

Rule //3 All f u n c t i o n s c a n be d i v i d e d i n t o t wo l e v e l s


of i m p o r t a n c e , b a s i c a n d s e c o n d a r y .

A. B a s i c f u n c t i o n : The p r i m a r y purpose
f o r a p r o d u c t or s e r v i c e .

B. Secondary f u n c tio n : Other purposes


not d i r e c t l y accom plishing the p r i ­
ma r y p u r p o s e b u t supporting it or
resulting from a specific design
a p p r o a c h . [20]

Rule number t wo r e q u i r e s the use of an a c t i o n verb and

a measurable noun in defining work functions. Examples of

action verbs are: enclose, protect, reduce, shield, etc..

f
Examples of measurable nouns are: air, energy, lig h t, oil,

water, etc.. In a d d itio n to the action verb and measurable

noun combination, an a d j e c t i v e may be u t i l i z e d if it aids in

clarifying the function without wrongfully lim iting it.

As described in rule number three, a function may be

classified as being either a basic or a secondary function.

Secondary functions may be seen as important, but are in no

way considered to control. [21] Secondary functions, can

better be described as supportive functions, and usually are


the result of a particular alternative which has been

chosen.

For example, let us consider a Value Engineering study

which identifies interior doors as a s y s t e m within a b u ild ­

ing construction project which has a very high cost-to-w orth

ratio. Function Analysis is employed in order to assist the

Value Engineering study team in its endeavor to explore

alternative methods of satisfying the needs which are

presently proposed to be fulfilled by the use of interior

doors. The primary function of an i n t e r i o r door can be

described with the sim ple action verb and measurable noun

combination, 'provide s e c u r i t y ' . The s e c o n d a r y functions

might be described as, 'co n tro l environm ent', 'prevent fire

expansion', 'contain n o ise ', 'exclude n o ise', etc.. Depend­

ing on the specific factors of the environment of a particu­

lar interior door, several of these secondary functions

might be reclassified as primary functions. For example,


for the interior door of a b o i l e r room e n t r a n c e , prevent

fire e x p a n s i o n would be c o n s i d e r e d to be a p r i m a r y function,

whereas the interior door of a secretary 's office might

categorize this same f u n c t i o n as a s e c o n d a r y function.

When d e f i n i n g the functions of an i t e m or system , the

Value Engineering study team must be s u r e to keep in mind

the intended purpose of defining the function. Onc e again,

the purpose is to aid in providing latitude in proposing

alternate designs. If the function of an i t e m being studied

is defined too strictly, the study team m ight not be able to

generate a sufficient number of applicable alternatives.

Moreover, if the functions are defined too broadly, they

might not define the function accurately enough to propose

proper alternatives.

To h e l p alleviate the dilemma described above, Func­

tional Analysis Systems Technique ( FAST) was developed. Th e

Functional Analysis Systems Technique utilizes a visual

technique entitled FAST D i a g r a m i n g . Figure 2.6 displays the

ground rules for developing a Functional Analysis Systems

Technique diagram. [22] A function answers the follow ing

question: Wha t does it do? The response to this question

may vary in degrees o f o r d e r . The FAST d i a g r a m graphically

displays the order in which these functions should be

placed. Th e function to the far left side of the diagram is

labeled as the h ig h e r order function. Th e basic or primary

function can be found to the immediate right of the higher


33

c
GROUND RULES
UHY 7
HOU 7
OESIGN

OBJECTIVE
FUNCTIONS

OESIGN

OF FUNCTIONS

HIOCR

FUNCTION
FUNCTION
FUNCTION FUNCTION

FUNCTIONS THAT HAPPEN

'AT TIC SATIE T1HE'

ANO/OR * ARE CAUSED SY'

SOIE OTHER FUNCTION

SCOPE o r PROBLBI fr

UNDER STUDY

Figure 2.6 Ground Rules f o r F u n c t i o n a l A n a l y s i s


S y s t e m s T e c h n i q u e ( FAST) D i a g r a m
34

order function, and a n s w e r s to the following question: How

does one provide the higher order function? A series of

required secondary functions are listed in a chain to the

right of the basic function. Moving toward the right along

the chain the secondary functions answer the following ques­

tion: How d o e s one p r o v i d e the function found to the immedi­

ate left of the function being examined? Using the same

logic, as one move s from right to left along the function

chain, the functions should answer the following question:


Why is it necessary to perform the function listed to the

immediate right of the function being examined? Functions

which take place at the same time and/or are caused by some

other function should be listed vertically below the said

function. Design objectives are listed in the upper left

corner of the diagram, and functions which happen all the

time are displayed in the upper right corner of the diagram.

If it is necessary to use an a d j e c t i v e in order to better

define a function, the adjective should be typed in

parenthesis and located on the lower line of the function's

box.

As discussed previously, Function Analysis can be per­

formed on a conceptual overview of the project or on c h o s e n

individual systems. Figure 2.7 is an e x a m p l e of a Function

Analysis Systems Technique diagram for an Infantry Fighting

Vehicle Operation and M a i n t e n a n c e Training Center. Figure

2.8 is an example of a Function Analysis Systems Technique


INCREASE MAINTAIN VHY
MINDGZE READINESS
KNOWLEDGE
LCC (COMBAT)

MAXIMIZE DESICN
WORTH OBJECTIVES

CONSERVE
ENERGY
FUNCTIONS VHICH HAPPEN
ALL THE TIME

TRAIN SIMULATE

TROOPS CONDITIONS
(FIELD OSM)

CONSTRUCT
HIGHER
FACILITY
ORDER
FUHTION
INSTRUCT ENCAGE
MAINTENANCE TRAINING
(IF V ) (CLASSROOM)

PRIMARY SECONDARY

FUNCTIONS FUNCTIONS

Figure 2.7 Conceptual FAST D i a g r a m E x a m p l e


36

M INIMIZE MAINTAIN
HOW VHY
ICC QRDILINESS
DESIGN
OBJECTIVES
MAXIMIZE PROVIDE
WORTH SAFTEY

J
FUNCTIONS WHICH HAPPEN
ALL THE TIME

CONSTRUCT
ACCESS CHANNEL DEFINE
WALK SIDEWALK
TRAFFIC
SURFACE

HIGHER
ORDER
FUNTION

BASIC SECONDARY

FUNCTIONS FUNCTIONS

Figure 2.8 FAST D i a g r a m for Sid e w a lk Network


37

diagram for the network of sidewalks for the same training

center. [23] The f i r s t d i a g r a m was constructed as an a i d for

examining alternative methods of satisfying overall concep­

tual functions of the center. The second diagram was con­

structed at the s a me time five others were being constructed

on the roof system, the water supply system, and various

other building systems of the project.

On c e the function diagrams are constructed and the

other inform ation gathering requirem ents are .s a tis f ie d , the

Value Engineering study t e a m may p r o c e e d to the Speculation

Phas e .

2.2.2 Speculation Phase

The second phase of the Value Engineering job plan 'is

entitled the speculation phase. During the course of the

inform ation phase, the Value Engineering study team chooses

to examine specific systems w ithin a construction project.

For each of these systems, a Function Analysis Systems Tech­

nique diagram should be constructed. The reasoning behind

developing these diagrams is to help facilitate a wide gen­

eration of alternative designs and construction methods

which satisfy the requirements of the chosen system. It is

the objective of the speculation phase to provide time in

which these alternatives may be generated. The Value

Engineering study team ne e d s to answer the follow ing ques­

tion during this phase: What other alternative w ill perform


38

the required functions? Conventional methods of satisfying

the primary function should not exclusively be t h e proposed

solutions. The V a l u e Engineering methodology requires that

the study team consider the functions and propose new­

fangled alternatives which m ight satisfy the necessary func­

tions. Since secondary functions are merely the result of

choosing a specific design method, primary functions are the

ones which the study team must be r e q u i r e d to satisfy.

Personal creativity aids the Value Engineering study


team in its development of novel alternatives. E a c h me mbe r

of the study team must utilize his own c r e a t i v e abilities in

order to be a d r i v i n g force in this phase. "Einstein said

that wh e n there is a problem to be solved, 'c re a tiv ity is

more important than know ledge'." [24] Although there are

many p s y c h o l o g i c a l theories which propose methods and tech­

niques concerning how to develop and foster an o p tim a l

environment which would maximize the productive efforts of a

p erson's creative abilities, only two common free-

association techniques and one organized technique w ill be

discussed at this time.

The first free-association technique is entitled

'b rain sto rm in g '. By d e f i n i t i o n , brainstorm ing is described

as "a conference technique by w h i c h a group spontaneously

generates and records m ultiple ideas which may l e a d to solu­

tions for a specific problem". [25] The brainstorm ing

approach is the most common t e c h n i q u e employed during the


39

speculation phase. The brainstorm ing session consists of a

random generation of ideas contributed by a l l team members.

During this session, no criticism of a ny form should be

tolerated. This is k n o wn a s the theory of deferred judge­

ment. It is enforced in order to prevent the intim idation


%

of study team members who w i s h to propose far-reaching solu­

tions. Therefore, the criticism is deferred to the analysis

phase, where it is not only welcomed, but encouraged. One

of the strong attributes of the brainstorm ing approach is

that a large number of w e l l - d i s t r i b u t e d solutions should be

proposed during the session. The s t u d y team leader should

encourage study t ea m members to combine and b u i l d off of the

proposed alternatives of others. Th e generation of wild and

outlandish ideas is advocated by the Value Engineering

methodology, during the idea generation phase.

The s e c o n d free-association technique, entitled the

Gordon technique, wa s developed by W i l l i a m J. J. Gordon.

This approach requires that the study team leader be the

only membe r who k n o ws exactly what is being studied. The

leader w ill ask the study team to use the brainstorm ing

technique on an i d e a which is remotely associated with the

actual item being studied. For example, if the item to be

studied is the construction of a w a r e h o u s e , the team leader

might ask the study team to perform the brainstorm ing tech­

nique on d i f f e r e n t methods of storage. It is felt that this

technique alleviates the problem of hasty development of


40

biases toward more popular solutions which would inhibit the

team 's creative potential for developing original solutions.

[26]

Morphological Analysis is an exa mple of a more c ommon,

organized approach to aid in the generation of ideas. It is

a structured and comprehensive method of developing a combi­

nations of ideas. Th e first step is the development of

variable parameters which affect the item being studied.

The next step is the development of a list of all possible


alternatives for each of the param eters. Th e f i n a l step of

the process is the construction of a v i s u a l model which

displays all possible combinations of all the alternatives.

[27] Figure 2.9 is an example of a m orphological analysis

performed on i n t e r i o r doors. The controlling parameters

were the size of the doors, the m aterial of the doors, and

the National Boar d of Underwriters fire rating of the door.

For sim plicity, a fourth parameter involving the type of

door frame was omitted from this analysis. Next, a series

of possible alternatives for each of the parameters was

developed. Onc e again, for sim plicity, only four alterna­

tives for each of the three parameters has been considered.

However, to perform a tru e morphological analysis, all pos­

sible alternatives for each parameter should be listed.

Finally, a visual m o d e l was constructed depicting all possi­

ble solutions. In this case, the model is a four by four by

four cube. Using this visual model, the study team could
41

1 . HOME

3 . B LABEL

4 . C LABEL

3 '-0 " 1 3 /4 "

2 ' - 6" 1 3 /4 " ♦ 3. ALUMIN.

3 '-0 " 1 3 /4 " >2. STEEL

2*-6” 1 3 /4 " >1. GLASS

C. SIZE -----------------------------------------1---------------- B. DOOR MATERIAL

Figure 2.9 M orphological Analysis Example


42

list all possible combinations for an interior door. For

instance, A- 2 x B- 2 x C - l would be a Steel, Fire Rating

Label A, 3'-0" x 7'-0" x 1.75" interior door.

Th e three approaches discussed above have been found to

be very c o mmo n l y a n d successfully used by V a l u e Engineering

teams. However any successful approach which promotes

creativity may be employed during the speculation phase.

Once a sufficient number of ideas has been generated for

each of the areas being studied, the study t e a m may p r o c e e d

to the next phase of the job plan.

2.2.3 Analysis Phase

All of the criticism s, evaluations, and analysis that

were deferred by the Value Engineering t e a m members w h i l e in

their speculation phase are welcomed in the analysis phase.

There are two major objectives of the analysis phase.

First, to choose the optimal a lt e r n a t iv e ( s ) for each system

and/or project being examined. Second, to be certain that

each chosen alternative satisfies all of the required func­

tions. Toward this end, the analysis phase employs three

tools: feasibility ranking, life cycle cost analysis, and

criteria m atrix applications.

The first step of the analysis phase involves the util­

ization of feasibility ranking. Since the Value Engineering

study maintains a definitive, allotted amount of resources


43

which it can employ, it w o u l d be u n f e a s i b l e and unadvisable

for the Value Engineering study team to undertake the enor­

mous task of investigating each proposed alternative which

was generated as a result of the speculation phase. There­

fore, the study team employs feasibility ranking in order to

rank according to feasibility all those alternatives which

were proposed earlier.

Figure 2.10 displays an e x a m p l e of a feasibility rank­

ing table. [28] If the study team requires differing cri­


teria than the ones listed in columns A through E, they may

change, insert, and/or delete criteria as they feel neces­

sary. In order to use the feasibility ranking method

correctly, the study team s h o u l d judge all of the alterna­

tives of a particular system against the criteria listed

be low.

A. State of the art.

B. Cost to develop.

C. Probability of im plem entation.

D. Ti me to implement.

E. Potential cost benefit.

For example, if passive solar design was considered as an

alternative while examining the exterior wall systems, it

should receive an a p p r o x i m a t e score of three whe n judged

against the criteria listed in c o l u m n A, state of the art,

since it employs relatively new t e c h n o l o g y .


ANALYSIS
V a lu e Engineering Study N u m b e r / D ate
W ORKBOOK / PHASE III
Study
Title

Feasibility

IM P L E M E N T
1 0 - E x c e lle n t c h a n c e
ART

OEVELOP

IM P L E M E N T A T IO N

sh o rt
O-New t e c h n o l o g y
Ranking

E POTENTIAL C O S T
OF

1 0 -L arg e S a v i n g s
lo n g
10 -O ft ihe s h e l l .
OF THE

List th e ideas th a t have,

0-No c h a n c e
PROBABILITY

0-No s a v i n g s
1 0 -E x tre m e ly
O-High c o s t
10-No c o s t

O -E x tre m e ly
in your ju dgm ent, ability to
TO

B E N E F IT
TO
m e e t th e re q u ir e d criteria.
A STATE

B COST

TIME
Rank e a c h idea from 1-1 0
for t h e s e factors >- TOTAL
C
RANKING

Figure 2.10 F easibility R a n k i n g Fo r m*

* Reprinted from the Army Corps of Engineer's Value


E ngi neering Workbook.
There are two methods of settling the inevitable

disputes a mo n g team members which w ill arise over the

assignment of scores. For the first method, each of the

study team members fills out a form sim ilar to the one shown

in Figure 2.10. An a v e r a g e for each box i s computed for all

team members. The s e c o n d method utilizes the Delphi tech­

nique. The Delphi process begins with a study team session

in which all members fam iliarize themselves with the problem

to be e x a m i n e d . During this session, the team begins to

develop a m ajority opinion of what the score should be. A

second session is held in which each t e a m me mb e r is asked to

express his views on wh a t the score should be a n d w h y . This

process is repeated until a consensus among all the study

team members is reached. [29] One a d v a n t a g e of this process

is that between sessions tea m members can modify their opin­

ions, which results in a give and take situation. As one

might expect, if an impasse is reached, the study team

should opt to utilize the earlier of the t wo m e t h o d s .

Once each of the scores for each of the criteria is

agreed upon, they are added together to obtain the total

score for each alternative. The total scores are ranked,

and those alternatives with the highest scores are con­

sidered to have the mo s t potential for producing a savings.

Therefore, a certain number of the top ranking a l t e r n a t iv e s

for each system being studied w ill be chosen for further

analysis, development, and investigation.


46

The next step of the analysis phase requires an

economic comparison among m u t u a l l y exclusive alternatives.

Life Cycle Costing is the most popular form of economic

analysis being presently utilized within the Construction

Industry. Other forms of economic comparison w ill be

presented in Chapter Four. The u s e of L i f e Cycle Costing

adds an enormous amount of credibility to t h e analysis pro­

cess. Alphonse J. D ell'Iso la and Stephen J. Kirk define

Life Cycle Costing for the design professional as "an


economic assessment of competing design alternatives, con­

sidering all significant costs of ownership over the

economic life of each alternative, expressed in equivalent

dollars". [30] Life Cycle Costing accounts for the different

costs of ownership such as initial construction costs,

future construction renovation and repairs, maintenance

costs, operating costs, and u s e r function costs. Life Cycle

Costing applies the principle of the time value of mo ne y to

these costs through the implementation of present value

analysis methods.

The V a l u e E n g i n e e r i n g program advocates the use of L i f e

Cycle Costing as an a i d in comparing alternative design and

construction methods. Unnecessary cost exists in initial

construction costs and life cycle costs alike. Although in

the past, owners have elected to reduce initial construction

costs only, the awareness of the potential paramount effects

of life cycle costs are changing the views of many owners.


47

Owners are now i n t e r e s t e d , if the additional funds are ini­

tially available, in enlarging their initial investment in

order to reduce the life cycle costs of their original

investm ent. In fact, many owners are investing resources

into retrofit alternatives on e x i s t i n g projects in orde.r to

alleviate the growing problem of life cycle costs.

The importance of life cycle costs as a major cost of

ownership is increasingly becoming recognized by o w n e r s .

The T r a n s p o r t a t i o n Research Board (TRB), in a recent report

entitled 'Value Engineering in Preconstruction and Construc­

tio n ', has realized, as shown in Figure 2.11, that life

cycle costs of operation and m a i n t e n a n c e a d d up to an aver­

age of fifty percent of total ownership costs. [31]

In typical office buildings annual costs can run any­

where between $0.50 and $5.00 per square foot. A savings in

these annual costs can offset a sizable increase in an ini­

tial investment, as shown i n the following example. Let us

say that a real estate developer decides to build an office

building with an initial investment of $50.00 per square

foot and expects to spend $5.00 per square foot in annual

costs. If a designer or value engineer or contractor on t h e

project develops several design alternatives requiring an

additional initial investment of $10.00 per square foot a nd

realizing a $3.00 per square foot savings in annual costs,

the owner may f e e l that the benefit does not compensate the

required costs. However, the present worth of a $3.00 per


48

TOTAL COSTS

Initial Costs

(< 50% of Total)

1
1
1 D PROCUREMENT OPERATION
1 E
1 s and and
I I
1 G CONSTRUCTION MAINTENANCE
1 N

*
Figure 2.11 T R B 's Life Cycle Cost D i s t r i b u t i o n

* R e p r i n t e d from ' V a l u e Engineering in P r e c o n s tr u c tio n and


Cons t r u c t i o n ' .

square foot annual savings over a useful life of 40 y e a r s at

a 10% i n t e r e s t rate is approxim ately $30.00 per square foot.

(PW = A ( P / A , i % , n y e a r s ) = $3.00 ( P / A , 10%, 4 0 y e a r s ) = $3.00

(9.779) = $29.34). The owner who w o u l d expend $10.00 per

square foot initially would realize a gross savings of

$30.00 per square foot in equivalent dollars. It is real­

ized that financing constraints exist on m o s t projects, and

that not all owners will be able to finance an a d d i t i o n a l

initial investment. However, not all alternatives raised

using life cycle cost analysis require an a d d i t i o n a l initial

investment. Some a l t e r n a t i v e s simply require a trade off or

a decreased initial investment, while realizing a sizable


49

annual savings over the entire life of the project.

There is a great deal to be said about the use of Life

Cycle Costing in Value Engineering. The estim ation of life

cycle cost data exists as a very pressing problem w ithin

the Construction Industry. Development of life cycle cost

data w ill not be a d d r e s s e d at this point; however, a large

portion of the remainder of this thesis w ill address the

problem of Life Cycle Costing w ithin the Construction Indus­

try. For now, it should suffice to state that the Value

Engineering methodology utilizes Life Cycle Costing to

economically compare mutually exclusive alternatives.

Toward this end, tables such as the one s h o wn i n Figure 2.12

are utilized during the analysis phase. [32] On c e a t a b l e

such as the one shown i n Figure 2.12 has been constructed

for all of the alternatives concerning a particular system

being studied, the Value Engineering study team i s enable to

choose the best economic alternative. Economic criteria,

however, is not the sole criteria which owners request to be

considered. Ow n e r s might require that the alternatives be

analyzed along other, non-quantifiable, criteria such as

aesthetics, tradition, or construction tim e.

A method entitled, 'C riteria Weighted Evaluation Pro­

c ess', was developed in order to isolate important criteria

and establish their relative w eights. [33] Figure 2.13

displays a criteria weighing chart. [34] In order to imple­

ment the C riteria Weighting Process, the criteria to be


50

S tudy N u m b e r D ate
V a lu e E n g in eerin g
PROPOSAL COMPARE
Study

Item Amounts below shown □ actual Life C y c le


□ in thousands □ in millions Cost Analysis
L ife C y r l e P e r io d yrs Present Proposal No. Proposal No.

8 a s e Cost
Interface 1
Initial C o s t s

C osts 2
3
O ther 1
Initial 2
C o sts 3
Initial C o s ts
Single E xpenditure ( %APR) Estimated A m t/ Estim ated A m t/ Estimated A m t/
and R e p la ce m en t

PW Factor x Est Amt Present Worth Present Worth Present Worth


/ / /
1 Y ear PW F a c to r
/ / /
3 Y ear PW F a c to r
/ / /
3 Y ear PW F a c to r
/ / /
* Y ear PW F a c to r
Salvage

S a lv a g e / / /
Y ear PW F a c to r

P r e s e n t Worth !
Annual C osts ( %APR) Estimated A m t/ Estimated A m t/ Estimated A m t /
PWA Factor x E st Amt Present Worth Present Worth Present Worth
1 M aintenance / / /
PWA Par.tnr
Annual C o s t s

2 O peration / / /
PWA F a c to r
3 / / /
PWA F a c to r
4 / / /
PWA F a c to r
5 / / /
PWA F a c to r
P r e s e n t W o rth
Total P r e s e n t W orth C o s t s
Life Cycle Savings

Figure 2.12 Life Cycle Cost Analysis Fo r m*

* Re printed from the Army Corps of Engineer's Val ue


Eng in ee ri ng Workbook.
51

c ANALYSIS
V a lu e Engineering Study N u m b e r / D ate
W ORKBOOK
/ PHASE III
S tudy
T itle

CRITERIA C rite ria


W eighing

(SUM OF SCORES
IN BOTH VERTICAL
AND HORIZONTAL)

GQ o ORDER

t:
t:
t:
c x:
t:
Preference
W e ig h tin g s

0 - N o difference
1 - M in o r
2
3 - M edium
4 t — — :
t:
5 - M a jo r

To e a c h box u n d e r S C O R E , b e s u r e to
w rite b o th th e letter re p re s e n tin g th e
P R O B L E M A R EA a n d t h e n u m e r a l o r c ip h e r
r e p r e s e n t i n g t h e W E IG H T IN G fo r t h e c h o i c e
y o u f e e l is m o s t i m p o r t a n t .

Figure 2.13 C riteria Weighing F o r m*

* Rep ri nt ed from the Army Corps of Engineer's Value


Engi ne er in g Workbook.

«
evaluated must be listed. For example, the list might

include cost, m aintainability, aesthetics, etc.. Based on

inform ation obtained from the owner, one should compare A

with B (cost vs. m aintainability), and place the letter

representing the most important criteria in the upper left

block of the m a t r i x . Next add to this block the appropriate

weight factor. Th e w e i g h t factor is determined by t h e speed

of the decision. For example, if a rapid and decisive

choice is made, then the weight factor should be assigned a


value of five. Compare A t o each of the other criteria,

determining the importance and w e i g h t of each. When t h i s is

done, step to B and compare it, on a o ne to one basis, to

each other letter criteria. Continue this process until

every element has been compared to every other elem ent.

After all elem ents have been compared, add t h e weight fac­

tors for each letter criteria, both vertical and horizontal,

and indicate the sum. Since the project is being reviewed,

examined, a nd scrutinized for the benefit if the owner,

either he or h i s representative should be present wh e n this

part of the a n a l y s i s is performed. This will insure that

all the views of the owner a r e properly represented.

On c e e a c h of the weights have been determined, they

should be transferred, in descending order, to the analysis

m atrix. The a n a l y s i s m atrix, which was developed in order

to evaluate the various m utually exclusive alternatives for

a system against the criteria and w eights, should be


53

completed by the Value Engineering study team. [35] Figure

2.14 displays a typical analysis m atrix. [36] Once e a c h

alternative is judged against each criteria on a basis of

one to five, the value is m ultiplied by t h e weight assigned

for that criteria. The numbers are then totaled horizon­

tally for each alternative, and the alternative with the

largest score is determined to be optim al. Initial costs

and life cycle costs are considered to be s t a n d a r d criteria.

They can be judged quite easily by u t i l i z i n g the inform ation

computed in the prior parts of the analysis phase. If the

Value Engineering study team, through the use of their

intuitive judgement and e x p e r i e n c e , feels that a less than

optimum c h o i c e was arrived at by this process, they w ill

reexamine the criteria, the criteria w eights, and the scores

assigned. If necessary, the study team s h o u ld he a l l o w e d to

overrule the choice. However, this option is generally only

allowable on the grounds that a less than economically

optimum alternative was arrived at, a n d wh e n owner approval

is granted.

2.2.4 Development Phase

The objective of this phase is to c l a r i f y all of the techni­

cal and required data for the alternatives which have been

selected as proposals to the owner for im plem entation. Dur­

ing the development phase a final report is prepared. In

addition, a brief factual presentation is assembled for the

owner in the fifth and final phase of the five phase


54

ANALYSIS
V alu e E ngineering Study N u m b e r / D ate
W ORKBOOK
/ PHASE III
Study
Title
BASIC FUNCTION A n a ly sis
List th e b e st id eas
"O (0
from ran k in g and
®-c M a trix
c o m p a riso n s te c h n iq u es. .b 3)
cn «-
D eterm in e w h ich o n e O'Z
s ta c k s up b e st ag ain st oo
th e d e sired criteria.
Weight
From . a b c d e f g h j
Criteria
Matrix Totals
Present
w ay / / / / / / / /
/ / y
/ / / / / / / / /

/
/ / / / / / /
/ / /
/ /
\

/ / / / / /
\

/ / / /
/ / /
/ /
7
/ / / // /
y
/
/ / / /
/
/ / / / / /
\

/
\
V

/
\

/ /
7
/ / / /
\

/ / / /
/
\

/ / / / /

E x cellen t-5 V ery G o o d -4 G o o d -3 F a ir-2 P o o r-1

Figure 2.14 Analysis M atrix Form*

* R e p r i n t e d f r o m t h e Army C o r p s of E ngineer's
Value E n g i n e e r i n g Workbook.
job plan, the pr es en ta ti on phase.

During this phase, all pertinent and related facts

about the alternative w ill be s o u g h t out and investigated.

The V a l u e Engineering study team must master each proposed

alternative and its plans for implem entation. If a design

or method u t i l i z e d in the development of an alternative is

determined to be incomplete or incorrect at a later date,

the reputation and credibility of the entire Value E n g i n e e r ­

ing methodology would be risked. In addition, the profes­


sional reputation of e a c h me mb e r of the Value Engineering

study team m i g h t be s a c r i f i c e d . Therefore, it is im perative

that the study team recommendations are checked and

rechecked to insure accuracy and to insure that the chosen

alternative consists of specifics, and n o t generalities.

In order to achieve the proper level of confidence

involving the underlying facts and f i g u r e s of the proposed

alternative, the study team should attempt to scrutinize

each and every aspect of the proposed alternatives them­

selves. After all, the study team w ill prefer that the

alternatives fail their own t e s t s and q u e s t i o n s , rather than

failing the owner's and o r i g i n a l d esigner's questions and

suspicions during the following phase. Toward this end, the

study team s h o u l d utilize and document the advise of consul­

tants, m anufacturer's representatives, and suppliers, with

respect to the proposed alternatives. Documentation w ill

set the groundwork that is needed to assure the owner of the


56

accuracy, validity, and reliability of the Value Engineering

study's results.

When a l l aspects of the proposed alternatives have been

investigated, the study team w ill have completed the

development phase and is ready to enter the proposal phase.

2.2.5 Presentation Phase

The o b j e c t i v e of this phase is to properly present and

outline an overview of the Value Engineering study's

results. At this point in tim e, the Value E n g i n e e r i n g study

team must employ special h u ma n relation and other management

skills. Without the study team 's ability to sell its

results and proposed alternatives, the entire Value

Engineering effort was for naught. The p r e s e n t a t i o n should

be ma de to both the owner (or an owner's representative),

and the original designer. The study team should take all

necessary precautions to prevent the Value Engineering

stu d y 's findings from b e in g viewed as a critique of the ori­

ginal design. If the original designer is insulted or

offended by the Value Engineering team 's presentation, a

political disagreement w ill begin over the validity of the

proposed alternatives. As w i l l be discussed in Chapter Ten,

many reasons exist why u n n e c e s s a r y costs are present in con­

struction projects. The study team s h o u l d attempt to remove

all roadblocks to the successful implementation of the

alternatives being proposed. Above all, their presentation


57

should be brief, pertinent, and c o n v i n c i n g . Complete docu­

mentation should be a v a i l a b l e to help aid the study team in

answering any inquiries accurately . However, the study

team s h o u ld not attempt to p r e s e n t this entire documenta­

tion. Only the results and recommendations need be

presented.

Many s o u r c e s of inform ation on p r e s e n t a t i o n techniques

and preparation exist. The f o l l o w i n g is a list of what a

Value E n g in e e r in g oral presentation should include, but need


not be lim ited to:

- Identification of the project studied.

- B r i e f s u mm a r y o f p r o b l e m (high cost, difficult


c o n s t r u c t i o n , et a l . ) .

- Description of original design.

- Cost of original design.

- Results " of Functional Analysis Systems


Technique( s ).

- Technical data supporting selection of the


alternative(s).

- Cost data supporting the a l t e r n a t i v e (s ).

- Advantages and disadvantages and reasons for


accepting a l t e r n a t i v e ( s ).

- S k e t c h e s of b e f o r e a n d a f t e r d e s i g n s , c l e a r l y dep­
icting proposed c h a n g e s ( d r a w i n g s marked to show
proposed changes are a c c e p t a b l e ) .

- Problems and cost of im plem entation.

- Acknowledgement of contribution by o t h e r s .

- Summar y statem ent. [37]


58

Certain considerations of basic h u ma n n a t u r e should be

considered when developing the presentation. The following

is a list of some of the mo r e important ones:

- People are interested in performance first.

- P e o p l e a r e i n f l u e n c e d by t h e effect adoption of
t h e p r o p o s a l w i l l h a v e on t h e i r s p h e r e o f w o r k .

- P e o p l e a r e p e r s u a d e d by t h e b e f o r e a n d a f t e r part
of the p r o p o s a l w ith a d v a n t a g e s and d i s a d v a n t a g e s
o f e a c h . [38]

These are a few of the basic communication skills which are

required in developing an effective Value Engineering

presentation. Development of the presentation will require

the management (possibly the Construction Management) skills

of the Value Engineering team. The s t u d y team w i l l be in a

marketing position, and its job w i l l be to sell the proposed

alternatives to the owner. As mentioned previously, the

success of the Value Engineering methodology and study w ill

depend upon the successful implementation of each step of

the job plan. Therefore, if the study team fails in the

successful completion of any one phase of the Value

Engineering job plan, it may result in the failure of the

entire study.

2^.3_ H i s t o r y and Background

D u r i n g W o r l d War I I and the years immediately follow ­

ing, a shortage of resources were experienced throughout the

United States. This shortage was created because many

resources were committed to the war e f f o r t . Lawrence M iles,


a staff engineer with General E lectric, was assigned the

task of improving product efficiency by perm itting the sub­

stitution of less expensive resources in place of more

costly ones without sacrificing the performance or function

of the product. Miles inserted his own s y s t e m a t i c approach

into a combination of existing techniques and methodologies

to develop Value Analysis. M iles' Value Analysis wa s w i d e l y

accepted within General Electric, and eventually other

members of the M a n u f a c tu r in g Industry, due to its quickly


proven success. Soon other companies, followed by several

other United S tate's government organizations, implemented a

Value Analysis program.

In 1954, Value Analysis wa s introduced for the first

time into the field of Engineering by the Navy B u r e a u of

Ships. [39] The m e t h o d o l o g y wa s renamed Value Engineering.

In 1962, Secretary of Defense Mc Na ma r a called for a mandate

which would require that Value Engineering be utilized to

reduce defense costs. Along the lines of McNamara's

request, t h e Ar me d Services included Value E n g in eerin g as a

mandatory requirement and defined it as follows:

A system atic effo rt directed at analyzing the func­


tional requirem ents of t h e D e p a r t m e n t o f D e f e n s e s y s ­
t e m s , e q u i p m e n t , f a c i l i t i e s , a nd s u p p l i e s f o r t h e pur­
pose of achieving essential f u n c t i o n s at the lo w e s t
to ta l cost, consistent with the needed performance,
r e l i a b i l i t y , q u a l i t y , and m a i n t a i n a b i l i t y . [40]

In 1963, the United States Navy Bureau of Yards was joined

by the Army C o r p s of E n g i n e e r s in being the first to utilize

Value Engineering w ithin the Construction Industry. When


these t wo agencies began to document the very successful

results of their Value Engineering programs, other branches

of the government began implementing forms of Value

Engineering w ithin their own p r o g r a m s . Agencies such as the

Bureau of Reclamation (1965), The Post Office Department

(1967), the Offices of the N a tio n a l Aeronautics and Space

A dm inistration (1969), and the Public Building Service of

the General Services Adm inistration (1969) began training

their personnel in and implementing forms of Value Engineer­

ing. [ 41]

In October, 1959, the Society of American Value

*Engineers (SAVE) was chartered. This society is dedicated

to the promotion and d e v e lo p m e n t of the principles of the

Value Engineering methodology. In addition, the Society

serves to certify experts w ithin the field of Value

Engineering. On c e one satisfies a number of stringent

requirem ents, he c a n be certified as a a C ertified Value

Specialist (CVS). At the 1972 ( 1 2 C^ ) Society conference, a

large group of m e m b e r s of the Construction Industry began to

receive ne ws of the accomplishments which Value E n g i n e e r i n g

was achieving in the public sector of the Construction

Industry. Many Federal and State government agencies were

represented. Th e news was so impressive that at the 1973

( 1 3 11^ ) Society conference, the m ajority of attendants were

me mb e r s of the Construction Industry. At this conference,

Paschen Contractors became the first private construction


61

firm to publicly document the success of its Value Engineer­

ing program. Th e y reported that on two, fifty five m illion

dollar jobs, their firm achieved four m illion dollars in

Value Engineering savings. [42] It had become apparent at

this time that Value Engineering had entered the arena of

the private Construction Industry. Mo r e surprisingly, no

mandates or legislation wa s needed to activate Value

Engineering w ithin the private Construction Industry; only

the documentation of the success and profit generating abil­


ities of Value Engineering would be needed.

Countless legislation has been enacted since then, and

many government agencies have documented vast success with

respect to Value Engineering within the construction pro­

cess. The Environmental Protection Agency ha s been very

successful at implementing a full scale Value Engineering

program, by r e q u i r i n g that Value Engineering studies be p e r ­

formed for any project over ten m illion dollars in size.

Significant savings have been realized by this agency

through the use of Value Engineering to elim inate unneces­

sary cost in their projects. Savings for 1971-1980 on s o me

one h u n d r e d projects were estim ated at approxim ately $160

m illion. [43] These savings represent a 5% r e d u c t i o n in

total costs and a $12 return for every dollar invested in

the Value Engineering studies. [44] The Army Corps of

Engineers has also introduced a full-scale Value Engineering

program with proven results. Since 1965, whe n the Corps


62

introduced contractor Value Engineering Savings Incentive

Clauses, it has realized a savings of approxim ately $24 m i l ­

lion through the use of these clauses, and $664 m illion

through Value Engineering studies as shown i n Figure 2.15.

In f a c t , at a recent meeting which the researcher attended

in 1983, the Ar my Corps of Engineers announced that they

were about to break the $1 b i l l i o n savings level. [45] For

every $1 the Ar my Corps of Engineers has spent on V a l u e

Engineering programs it has realized an a v e r a g e savings of

$20. [46]

Value Engineering is no longer a tool strictly employed

w ithin the United States; its principles have been spread

throughout the world. At a recent m eeting which the

researcher attended, Larry Miles announced that he h a d

recently returned from a t r i p to Japan in w h i c h h e was asked

by the Japanese Government to award four M iles' Value

Engineering Awa r d s to a Japanese construction company which

has implemented Value Engineering programs with exceedingly

remarkable success. [47] Mr . Miles pointed out that the

Japanese have taken a hold of the Value Engineering concept,

and their utilization of Value Engineering concepts have by

far exceeded those of the United States. It seems the

Japanese are using Value Engineering to increase their effi­

ciencies in many different ways, and the United States, to

remain in a competitive position, w ill have to begin to

copy the Japanese methods of implementing a tool which the


ACCUMULATED GOALS AND SAVINGS FROM ALL VE ACTIVITY
700

600

<A
Z 500 NOT INCLUDED IN THE G RA PH S ARE
O $ 7 6 .6 9 6 ,5 0 0 IN SAVINGS FROM THE
MIDDLE EAST DIVISION.
s $ 4 1 5 ,9 0 0 ,0 0 0
O 400
111
> IN-HOUSE, BOTH CIVIL
< AND MILITARY
<A
IS 3 0 0
B
21 SAVINGS
_j
€ o
a
200 GOALS
S
z
100
CONTRACTORS’ VE
CHANGE PRO PO SA LS 2 4 ,3 5 2 ,1 3 6

65 67 69 71 73 75 79
FISCAL YEARS

Figure 2.15 Army C o r p s of E n g i n e e r s Value Engineering


Summa r y o f Savings

* R e p r i n t e d from t h e Department o f t h e Army O f f i c e o f


C hief of E ngin eers 1980 Value Engineering Progress
Repo r t .


64

United States developed. As mo r e a n d mo r e Value Engineering

success cases are documented, it becomes mo r e a p p a r e n t that

Value Engineering can be e m p l o y e d as a modern innovative

tool of improving market efficiencies.


CHAPTER 3

VALUE ENGINEERING WITHIN THE CONSTRUCTION INDUSTRY

. 1_ Introduction

Value Engineering was first introduced to the Construc­

tion Industry in the early 1960s. Its success was esta­

blished through use in construction by s e v e r a l governmental

agencies. Nearly t wo decades later, Value Engineering has

taken a firm foothold within the Construction Industry and

enjoys widespread use by b o t h the public and private sec­

tors. It has been enacted into legislation in the United

States congress, and adopted into many w i d e l y used construc­

tion contracts. However, to date no known survey of the

C onstruction Industry, with respect to the use and knowledge

of Value Engineering, exists.

The C onstruction Industry makes use of Value Engineer­

ing through t wo common m e t h o d s . First, through the use of

Value Incentive Clauses, c o mmo n l y known a s VICs, and second

through the use of Value Engineering studies.

Value Incentive Clauses are clauses included in con­

struction contracts which encourage a construction


66

contractor to propose alternate designs, construction

methods, or specifications by o f f e r i n g to s h a r e a portion of

the savings realized through the implementation of the pro­

posed alternative, with the contractor.

Value Engineering studies are studies performed by a

project team which follow a Value Engineering job plan in

presenting alternative design proposals without sacrificing

the functional requirem ents of the project. These studies

are usually performed while the project is still in the


design and planning phases.

This chapter w ill be devoted to presenting the results

of a survey involving several integral parts of the Con­

struction Industry with respect to their use and knowledge

of Value Engineering techniques. The survey wa s implemented

through the use of several questionnaire forms which were

mailed to representative databases in the fall of 1983.

3_. 2_ Th e S u r v e y

3.2.1 Objectives of the Survey

Th e overall objective of the survey was to establish

the use and knowledge of Value Engineering by the separate

divisions which make up the Construction Industry. Several

other related topics were examined with the same survey

instrum ents. To effectively survey a representative cross


67

section of the Construction Industry, four different groups

were chosen as a database for the survey. The four samples

chosen were to represent the following populations : 1)

large size national contractors, 2) small to medium size

local contractors, 3) design firm s, and 4) Value Engineering

consulting firm s.

Individual objectives of the survey of each group were

as follows:

I . Large Size N ational Contractors

A. To s u r v e y the knowledge of Value Engineering and

its methodology among l a r g e contractors.

B. To s u r v e y the use and contact that large contrac­

tors have with Value Engineering Incentive Clauses

(VIC) in their contracts.

C. To s u r v e y the amount of interest large contractors

have in learning more about Value Engineering

through publications, conferences, and training of

their own personnel through the use of forty hour

Value Engineering workshops.

D. To s u r v e y the C onstruction Industry with respect to

its use of Uniformat, M asterform at, or its own com­

pany form at.


68

E. To survey the classification of projects which use

Value Engineering. (eg. International vs. U.S.,

Private vs. Public, size)

II. Small a n d Me d i u m S i z e Local Contractors

A. To s u r v e y the knowledge of Value Engineering and

its methodology among me di um s i z e contractors.

B. To s u r v e y the use and contact that medium s i z e con­

tractors have with Value Engineering Incentive

Clauses ( VIC) in their contracts.

C. To s u r v e y the amount of interest medium size con­

tractors have in learning more about Value

Engineering through publications, conferences, and

training of their own p e r s o n n e l through the use of

forty hour Value Engineering workshops.

D. To s u r v e y the Construction Industry with respect to

its use of Uniformat, M asterformat, or its own com­

pany format .

E. To s u r v e y the classification of projects which use

Value Engineering. (eg. International vs. U.S.,

Private vs. Public, size)

III. Design Firms

A. To s u r v e y the knowledge of Value Engineering and

its methodology among design firm s.


69

To s u r v e y the use and contact that design firms

have with Value Engineering Incentive Clauses (VIC)

in t h e i r contracts.

C. To s u r v e y the amount of interest design firms have

in learning more about Value Engineering through

publications, conferences, a nd training of their

own personnel through the use of forty hour Value

Engineering workshops.

D. To s u r v e y the design firms with respect to their

use of Uniformat, M asterform at, or their own com­

pany format .

E. To s u r v e y the classification of projects which use

c Value Engineering. (eg. International vs. U.S.,

Private vs. Public, size)

F. To e s t a b l i s h what fears these firms have of Value

Engineering. (The researcher is hypothesizing that

the results of this survey will s how t h a t most of

the design firms oppose Value E n g i n e e r i n g . )

G. To s u r v e y design firm s' methods of establishing and

developing life cycle cost data to be u s e d in com­

paring design alternatives.


70

I V. Value Engineering Firms

A. To e s t a b l i s h the percentage of Value Engineering

firms involved in performing Value Engineering stu­

dies for Construction Industry projects.

B. To survey the Value E ngineering firm s' involvement

in Value Incentive Clauses with the contractor.

C. To survey the Value E ngineering firms with respect

to t h e i r use of Uniformat, M asterform at, their own

company format.

D. To survey the classification of projects which use

Value Engineering. (eg. International vs. U.S.,

Private vs. Public, size)

E. To survey the methods used by Value Engineering

Firms in establishing life cycle costs for con­

struction projects.

3.2.2 Th e Survey Instrument

The m e t h o d of survey chosen wa s the use of a question­

naire which would be m a i l e d to a sufficiently sized sample

representing each of the four groups involved in the survey.

A cafeteria style questionnaire, which investigated those

topics which were item ized in the objectives of the

survey, wa s developed. A combination of the different


71

characteristics of the four groups being surveyed, and the

different objectives for surveying the four groups, led to a

decision to create four separate survey instrum ents.

Although the four survey instrum ents essentially surveyed

the s a me topics, each o ne wa s tailored to the specific

characteristics of the group it pertained to.

The survey instruments were divided into three dif­

ferent categories, each examining a different topic. The

first category, consisting of t wo q u e s t i o n s , collected bio­

graphical data concerning the size of the organization and

type of work it is involved in. The second category con­

sisted of a series of questions which sought to collect in

depth inform ation about the o rg anization's use, knowledge,

and interest of Value Engineering w ithin the Construction

Industry. The third category consisted of four questions

which briefly surveyed the use and knowledge of construction

cost coding formats in these organizations. The survey

instrum ent utilized both qualitative and q u a n t i t a t i v e ques­

tions. A sample of one of the four surveys can be f o u n d in

Appendix A.

3.2.3 Database

Four separate databases were used to represent each of

the four groups chosen to be s u r v e y e d . The Top 200 Contrac­

tors listed in "The 1983-84 Engineering News Record Direc­

tory of Contractors", which are ranked using new c o n t r a c t


72

awards volume, served as the sample for the large size

national contractor group. Fifty selected members of the

Indiana membership of the A ssociated General Contractors and

the Indiana Constructors served as the sample of me d i u m a n d

small size local contractor group. The Top 250 Designers in

"The 1983-84 Engineering News Record D irectory of Design

Firms", which are ranked using volume of annual billings,

served as the sample for the design firm group. Seventy

five Value Engineering consultants listed in the "Directory


of V a l u e A n a l y s i s & Value Engineering Consultants", which is

printed by the Society of Value Engineers, served as the

sample for the Value Engineering firm group.

Large size national contractors were separated from

me d i u m and small size local contractors, providing t wo

separate databases that were compared and contrasted, and

yielded several valuable observations. The input provided

by s u r v e y i n g design firms was considered to be very impor­

tant, since the success of any V a l u e Engineering effort is

dependent upon the cooperation of the p ro ject's original

des i gne r .

Of the 570 q u e s t i o n n a i r e s m ailed, 539 reached their

original destination. A total of 31 q u e s t i o n n a i r e s were

returned prior to reaching their intended destination. Of

the 539 (corrected total) questionnaires m ailed, a total of

129, or 23.9 percent, completed questionnaires were

returned. Of the four groups surveyed, the Indiana


73

Associated General C ontractor's and Indiana C onstructor's

membership had the highest response rate, at 40.0 percent.

The E n g i n e e r i n g News Record Top 250 Design Firms had the

lowest response rate, at 18.7 percent. The p e r c e n t a g e

returned was computed using Equation 3.1.

„ _ , _ Nu mb e r o f Q u e s t i o n n a i r e s R e t u r n e d ,„ . .
° 6 urne “ Nu mb e r o f Q u e s t i o n n a i r e s M a i l e d ( c o r r . )
whe r e :

Numbe r of Q uestionnaires Mailed (corr.) = Th e Number of

Questionnaires which were not returned.

A s u mma r y of the questionnaire response rates for the

four individual samples and all four samples totaled is

s h o wn i n Table 3.1.

3^.3^ S u r v e y Results

On c e the surveys were returned, the quantitative

results for each individual group were tallied and statisti­

cally analyzed. The results of those questions which

resulted in the attainm ent of usable information were com­

bined for all four of the individual groups in tables.

Those tables w ill be presented and discussed in the follow­

ing pages. Q ualitative results were summarized into typical

responses, and w ill also be presented and discussed in the

following pages.

The results in Table 3 . 2 s how t h a t the m ajority, rang­

ing from 97.7 percent f o r the large contractors, to 95.0


74

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percent for the design firm s, who r e t u r n e d the survey had

k n o wn what Value Engineering studies are. The Value

Engineering firms sampled were not asked this question,

since they should obviously know w h a t a Value Engineering

study is. In addition, a sm aller percentage, ranging from

80.0 percent for the design firm s, to 84.1 percent for the

Indiana A ssociation of General Contractors and the Indiana

Constructors group, knew wha t Value Incentive Clauses are.

To c l a r i f y the definition of these t wo forms of Value


Engineering, and to aid in defining a common m e a n i n g for

these t wo t e r m s so that those being surveyed would have a

uniform understanding of the topic wh e n answering the

remainder of the questions on the survey instrum ent, the t wo

definitions shown below were presented in the survey instru­

ment.

Value Engineering- is a system atic method of reviewing the

design of a project and reducing unnecessary costs without

sacrificing performance, reliability, m aintainability, a nd

delivery. The study is performed by a small group of

trained Value Engineers within a forty hour workshop. The

function of each system within the building is analyzed and

alternative methods of satisfying these functions are com­

pared using life cycle costs, not just initial costs.

Value Incentive Clauses ( VIC) - Clauses included in construc­

tion contracts which share life cycle savings , which were


77

realized because of alternative designs developed by the

contractor, with the contractor.

Table 3.3 presents the response of the individual

groups when asked if they had p r e v i o u s l y been involved in

the submission of a proposed alternative under a Value

Incentive Clause. 56.8 percent of the Top 200 E n g i n e e r i n g

News Record Contractors had submitted Value Incentive

Clauses, and 36.4 percent of the Top 250 E n g i n e e r i n g News

Record Design Firms had been involved in the submission of

proposed alternatives under Value Incentive Clauses, which

represented the higher and lower ends of the range of

response respectively. It is worth noting that a very high

percentage, ranging from 61.9 percent to 43.2 percent, of

the participating organizations have not had any prior

experience or involvement with Value Incentive Clauses.

When a s k e d to judge their experience with Value Incen­

tive Clauses, 52.2 percent of the Top 200 E n g i n e e r i n g News

Record Contractors felt their experience with these Clauses

was either advantageous or satisfactory. The most notable

response to this question was that very f ew o f these organi­

zations described their experience with Value Incentive

Clauses as disadvantageous. In fact, t wo of the organiza­

tions did not have any respondents who h a d found their

experience with these clauses disadvantageous. Th e lack of

response to this question is explained by the lack of

experience or involvement with Value Incentive Clauses as


78

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79

mentioned above. The response to this question is presented

in Table 3.4.

The following is a list which summarizes the response

to a question which asked the organizations to state what

incentive was offered, if any, to submit an alternative,

under any Value Incentive Clauses which they have had con­

tact with. The responses are listed in order of frequency

(most frequent response is listed first a nd the least fre­

quent response is listed last). Th e frequency of each


response to this question was sim ilar a mong e a c h of the four

individual groups.

1. A percentage share in the initial and/or life cycle

savings which result from the implem entation of the

proposed alternative is given to the contractor and the

remainder of the savings goes to the owner.

2. The g e n e r a t i o n of p r o p o s e d a l t e r n a t i v e s was used as a

marketing tool which aids us in marketing our services

over those of our com petitors.

3. The s u b m i s s i o n of a l t e r n a t i v e methods of design and

construction was a prerequisite to being a bidder on

the project.

4. The s u b m i s s i o n of a l t e r n a t e proposals was needed to

force the project into budget and aid in making the

project become a r e a l i t y .

«
80

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81

5. The s u b m i s s i o n of better alternate designs and con­

struction methods are the responsibility of any good

contractor .

6. The submission of alternate proposals aids us in

increasing the project scope and also in helping the

owner receive a mo r e efficient project.

7. The p r o p o s e d alternatives were used to clarify certain

aspects of the design, thereby reducing our

organization's risk exposure.

8. Our s e r v i c e s involved in the generation of alternative

methods of design and construction were paid for by the

owner on a h o u r l y basis.

Table 3.5 displays the response of the four surveyed

groups wh e n asked if their organization has ever been

involved in a pure (as described by the definition) Value

Engineering study for a construction project. Both the Top

2 50 Engineering News R e c o r d Design Firms and the Top 200

Engineering News R e c o r d Contractors had a s u r p r i s i n g l y high

percentage which responded to the question affirm atively,

72.7 percent and 65.9 percent respectively. Value Engineer­

ing firms had the highest affirm ative response rate, at 90.5

percent, as was expected. However, the Indiana Associated

General Contractors and Indiana Constructors membership had

a much lower rate of experience, which would lead to the


82

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83

conclusion that sm aller size, local contractors do not get

as much exposure to modern construction management tools,

such as Value Engineering, as do larger size national con­

tractors .

In Table 3.6, 66.6 to 30.0 percent of the organizations

claim that any value engineering studies they were involved

in were performed previous to the construction phase of the

project, either during the plan development, during the

final design phase, or just prior to construction. Five


percent of the Indiana Associated General Contractors and

Indiana Constructors membership were the only respondents

who indicated that they had been involved in a value

engineering study during the actual construction phase of

the project.

Only 4.5 percent of the Top 200 E n g i n e e r i n g News R e c o r d

Design Firms felt that the value engineering studies they

had been involved in did not prove t o be productive to the

owner, as shown i n Table 3.7. A productive value engineer­

ing study is o ne in which the actual savings realized

through the implementation of the proposed alternatives gen­

erated by the study, are greater than the cost of the actual

study and the implementation costs of the proposed alterna­

tives. Implementation costs are costs required to implement

the proposed alternatives. For example, the cost of

redesign and redrafting the plans for a proposal would be

classified as an implem entation cost of that proposal. A


84

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Tabl e 3.7 Summary to Sur vey Q u e s t i o n ; If l o u r O r g a n i z a t i o n Has Been I n v o l v e d in
" P u r e " Value E n g i n e e r i n g S t u d i e s , Did They Prove To Be P r o d u c t i v e

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range of savings:cost ratios from less than five:one to

greater than one hundred:one were e s t i m a t e d as the

savingsicost ratio of value engineering studies which these

organizations had been involved in, as shown in Table 3.8.

Table 3.9, Table 3.10, and T able 3.11 present the

response to questions asked in the survey which sought to

identify the source of contracts, the type of work, and the

type of construction contracts with which these individual

groups have gained experience with value engineering studies

and/or value incentive clauses. In Table 3.9, 59.1 to 14.3

percent of the organizations have had experience with Value

Engineering in private construction, and none of the organi­

zations have had experience with Value Engineering outside

of the United States; 57.1 to 15.0 percent h a v e had e x p e r i ­

ence with Value Engineering in some combination of Federal,

State, and/or Private contracts. In Table 3.10, 22.7 to 4.8

percent of the organizations have had experience with Value

Engineering in commercial construction, and 61.9 to 5.0 per­

cent have had experience with it in s ome combination of c om­

m ercial, institutional, heavy, industrial, m ulti-residential

and/or highway construction. Table 3.11 shows that the use

of Value Engineering is evenly distributed a mo n g d i f f e r e n t

types of construction contracts, such as com petitive bid,

negotiated, construction management contracts, or some com­

bination of the above three. C onstruction management con­

tracts were the least mentioned for involving Value


87

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91

Engineering, with only 10 t o 0.0 percent of the organiza­

tions checking off this response.

Table 3.12 indicates that 90.5 to 38.6 percent of the

organizations would like to see Value Incentive Clauses

being used more often within the Construction Industry, and

100.0 to 79.5 percent of the organizations would like to see

Value Engineering studies being used mor e often in the

future. With the exception of value engineering firm s, the

m ajority of the organizations feel, as s h o wn in Table 3.13


and Table 3.14, that any size project would benefit from the

implem entation of Value Incentive Clauses and Value

E n g i n e ’e r i n g studies. The m ajority of value engineering

firms felt that one m i l l i o n dollar or less projects were the

sm allest size jobs which could benefit from the implementa­

tion of V a l u e Incentive Clauses and/or Value Engineering

studies.

Listed below are the problems which the surveyed organ­

izations feel are inherent in the use of Value Incentive

Clauses. The most frequent responses are listed first.

Some of the responses were received from d e s i g n firms and

others were received from c o n t r a c t o r s ; either case is usu­

ally obvious .

1. It is difficult to reach a mutually acceptable agree­

me nt over the price which should be paid to the


92

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95

contractor by the owner u po n implem entation of the pro­

posed alternative.

A fear of design liability by contractors and design

firms for alternate design proposals submitted by the

contractors .

A feeling by design firms that contractors propose

lower quality and cheaper equipment, m aterials, and/or

construction methods in order to generate initial sav­

ings for the owner, which in t u rn would be shared by

the contractor.

The s u b m i s s i o n , approval, and redesign process results

in untim ely and u n a c c e p t a b l e delays in the schedule of

the project.

Contractors and Value Engineering firms find that the

d esigner's pride, with respect to the original design,

becomes a major roadblock to implementing mo r e attrac­

tive alternatives.

Contractors and Value Engineering firms feel that

d esigner's methods, used to review proposed alterna­

tives, are inexcusably and unacceptably inadequate.

Contractors and designers alike find that there is

insufficient life cycle cost data available to allow

them to compare a l t e r n a t i v e proposals properly.


96

8. Contractors, Value Engineering firm s, and designers

find that the original design firm lacks the necessary

time to perform the appropriate evaluation of proposed

alternatives subm itted.

9. It is felt that the impact which proposed alternatives

have on o t h e r systems w ithin the building is not always

easily seen, and i s even h a r d e r to evaluate.

10. Designers state that contractors have no way o f knowing


exactly what the owner's needs and wants are.

11. Value Engineering firms feel that owners and owner's

representatives lack sufficient knowledge of Value

Engineering methodology, and the entire design and con­

struction process, to be a b l e to look after their own

interests, such as seeing that Value Engineering is

used to better the value of their project.

12. Contractors are apprehensive about being responsible to

the owner under a guarantee for the estim ated life

cycle cost savings of the proposed alternative.

13. Value Engineering firms stated that contractors do not

employ their option under Value Incentive Clauses

because they do n o t fully understand how to use them.

14. Contractors find that the cost of pursuit once a

designer assumes an adversary position pertaining to

the acceptance of a p r o p o s e d alternative which revises


97

his original design, is far greater than the benefit

which might be gained once the alternative is accepted.

15. Design firms stated that in far too ma n y cases, con­

tractors overlook the essential life cycle cost con­

siderations, and simply concentrate their efforts on

the initial costs and benefits of a p r o p o s e d alterna­

tive.

16. Contractors have found that owners are not interested

in potential life cycle cost savings and benefits,

because there is no g u a r a n t e e that the life cycle bene­

fits w ill ever m aterialize.

17. Designers stated that the anim osity created by the sub­

mission and the approval problems of Value Incentive

Clauses would u l t i m a t e l y result in the breakdow n of the

working relationship among the members of the building

team.

18. Designers felt the contractors are prone to kickback

offers from manufacturers and suppliers, who are

interested in a t t a i n i n g design changes for their own

benefit, with these clauses.

19. Designers stated that Value Incentive Clauses apply the

theory of Value Engineering too late in the project

development process to make a n y sizable savings.


98

20. In a d d i t i o n , designers stated that the owners consider

Value Engineering as a responsibility of the original

designer, and they are not interested in paying extra

for it.

Since the success of Value Engineering is very much

dependent upon the acceptance and even the promotion by the

original designer of a project, the design firms were asked

to state any problems which they have experienced or fear


with respect to Value Engineering. The follow ing is a list

of the responses listed in order of most frequently

received .

1. Value Engineering is usually performed mu c h too late

during the design phase of a project, and therefore

results in costly redesign work and in addition, delays

to the p ro ject's schedule.

2. Designers view proposed alternatives as insults to

themselves and their work.

3. Human r e l a t i o n s , roadblocks, and other psychological

aspects of Value Engineering are usually not handled in

the correct manner.

4. There is an i m p o r t a n t question of design liability for

all parties involved in the project, from conception

until the finish of construction.


99

5. To a p p r o v e and review the proposed alternatives is too

costly, and outweighs the benefits of Value Engineer­

ing .

6. Some o w n e r ' s criteria and n e e d s do not include life

cycle costs, and are exclusively dependent upon the

initial costs of the project.

7. There is usually not enough time to properly evaluate

and implement proposed alternatives.

8. Clients w ill not pay for Value Engineering. They may

consider it a service which the original design firm

should supply.

9. Th e V a l u e Engineering team u s u a l l y does not understand

the needs and intents of the owner.

10. Estim ation of the savings is not quantifiable enough to

base any sort of analysis on.

11. Finding experienced C ertified Value Specialists (CVS)

and knowledgeable team members is a very difficult

task .

In Table 3.15, 95.2 to 70.5 percent of the organiza­

tions felt that they would be interested in learning more

about Value E n g i n e e r i n g and its applications within the Co n ­

struction Industry. The majority of the organizations felt

they would be interested in learning more about Value


100

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101

Engineering through the use of publications. Conferences,

sending personnel to forty hour Value Engineering workshops,

and s o me combination of the above three methods were also

very f r e q u e n t responses, as shown i n Table 3.16 . Th e fol­

lowing is a list of reasons why c e r t a i n organizations were

not interested in learning more about Value Engineering and

its application w ithin the Construction Industry. The list

is in order of frequency, with the most frequent response

listed first.

1. They already perform Value Engineering, and feel they

do n o t need to know a n y mo r e about the topic.

2. They feel they already know e n o u g h about the subject,

and do n o t care to learn any more.

3. They have their own i n - h o u s e Value Engineering training

program.

4. Th e design liabilities involved in Value Engineering

outweigh the the possible benefits which can be

attained .

5. Pure Value Engineering is not appropriate for private

work.

They do not like the Value Engi ne er in g methodology.


f
Tabl e 3.16 Summary to Sur vey Q u e s t i o n ; In What Ways Would Your O r g a n i z a t i o n be
Interested in L e a r n i n g More About Value E n g i n e e r i n g ?
102

This was not offered as an alternative to this group.


7. Government restrictions and design criteria are too

stringent for Value Engineering to be of any signifi­

cant benefit to government projects.

After surveying the topic of Value Engineering, the

survey instrument briefly switched topics to examine the use

and knowledge of construction cost coding formats within the

Construction Industry. The results are presented below. In

order to uniformly define what is meant by the terms: con­

struction cost coding format, M a s t e r f o r m a t , and Uniformat,

the following definitions were presented just prior to those

questions which examined the topic of the use and know ledge

of construction cost coding format w ithin the Construction

Industry .

Construction Cost Coding F orm at- A construction cost coding

format is a format which provides a numbering system for the

accum ulation of project cost data and classification of this

data under separate work items.

Mas t e r f o r m a t - is a construction cost coding format developed

by the Construction Specifications Institute. It is a pro­

duct oriented form at. This format is based on the original

16 d i v i s i o n CSI format.

Uniformat- is a construction cost coding format developed by

the General Services A dm inistration/ Public Building Service


( GS A / P B S ) and the American Institute of A rchitects (AIA).

It is mo r e of a Building Systems form at.

The results in Table 3.17 indicate that 90.9 to 90.0

percent of the contractors use a construction cost coding

form at, and 90.9 to 61.9 of all four of the groups surveyed

use a construction cost coding form at. Table 3.18 shows

65.0 to 29.5 percent of the organizations surveyed use a

company developed construction cost coding form at. These

percentages represented the m ajority for all four groups,


except the Top 250 Engineering News R e c o r d Design Firms, who

used the Masterformat more than a company developed con­

struction format. Th e second most used format for the other

three groups surveyed was the M a s te rf o r m a t. Th e Uniformat

wa s only used by 6.8 percent of the Top 250 E n g i n e e r i n g News

Record Design Firms and 23.8 percent of the Value Engineer­

ing Firms. Only 29.5 percent of the Top 200 Engineering

News R e c o r d Contractors were interested in learning more

about the M asterformat or the Uniformat, as s h o wn i n Table

3.19 . The m a j o r i t y of the three other groups of organiza­

tions expressed their interest in learning mo r e a b o u t either

the Uniformat or the M asterform at.

A very important aspect of Value Engineering requires

that the alternatives be a n a l y z e d using the total costs of

ownership to the owner over the total economic life of the

building, and that these costs be e x p r e s s e d on a n e q u i v a l e n t

basis. This idea is the concept of Life Cycle Cost


105

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108

analysis. It is used in the Value Engineering job plan at

t wo i m p o r t a n t phases. In the inform ation phase, Life Cycle

Costing is used to identify areas of high unnecessary costs

and poor value. Life Cycle Costing is also employed in the

analysis phase. In this phase, alternatives are compared on

the basis of their life cycle costs.

The following is a summarized list of the main method

which the organizations surveyed listed as the system they

use to estim ate life cycle cost data needed to perform life

cycle cost analysis in either Value Engineering or ordinary

design analysis. Th e m e t h o d s used were distributed equally

across all four of the responding groups, and a r e listed in

the order of frequency.

1. Th e owner provided the necessary life cycle cost data.

2. Their own h i s t o r i c a l data files and past records were

used. (A h i s t o r i c a l data base method)

3. They use estim ates and formula computations to develop

the needed life cycle cost data. ( An e n g i n e e r e d , or

scientific method)

4. They do n o t bother using life cycle costs in their cal­

culations; they simply rely on i n i t i a l costs.

5. They use inform ation supplied by m anufacturer's

representatives and m anufacturer's product inform ation

sheets .
109

6. General knowledge and experience with sim ilar projects

is employed.

7. They gain knowledge through interview s with m aintenance

and operating staff and other personnel who are

employed by the owner on s i m i l a r projects.

8. Outside consultants are hired on a n h o u r l y basis.

9. Published data in trade m agazines, government agencies

or agencies such as the American S o c i e t y of Heating and


R efrigeration E n g i n e e r s (ASHRAE) or Building Owners and

Managers A ssociation (BOMA) is used.

10. Interviews and b i d s from m a i n t e n a n c e and operating sub­

contractors are considered.

11. Us e i s made of general estim ations based on p e r c e n t a g e s

of the initial cost estim ate.

12 Life cycle costing is not performed. The owner evalu­

ates that aspect of the analysis.

13. Interview s and i n f o r m a t i o n supplied by u t i l i t y agencies

is used.

14. A f ew o f the organizations own facilities sim ilar to

those that they design, and can apply the pertinent

data they collect on the projects they own to the

facility being analyzed.

f
110

15. A few of the organizations stated that lending institu­

tions supply them w i t h the needed l i f e cycle cost data.

3^4_ Summar y a n d Conclusions

The results of the survey are encouraging. Th e Con­

struction Industry has a reputation of being very sim plistic

and crude in their m anipulation of innovative management

techniques. The industry has had a h i g h rate of company

failures in recent years. Dun & B r a d s t r e e t , Inc., New York

City, has reported a fifty year high of 5,262 contractors

went out of business in 1983. The number of co n tracto r's

failures reported in 1983 broke the previous 4,959 firm

record set in 1982. [48] Yet, the survey portrays an indus­

try which recognizes that changes are required. The major­

ity of firms approve of Value Engineering, and would appre­

ciate mo r e applications of it throughout the industry.

Through the use of more e f f i c i e n t designs and c o n s t r u c ­

tion methods, owners could realize a new s u r p l u s of funds.

This could result i n a new surge of c o n s t r u c t i o n projects,

which would be greatly welcomed w i t h i n the Construction

Industry. With on going s t u d i e s , such as the Business

Roundtable's "Construction I n d u s t r y Cost Effectiveness Pro­

ject Report," it is amazing how little research exposure

Value Engineering techniques have received within the Con­

struction Industry. In spite of this, the results of the


Ill

survey have y i e l d e d s ome i n s p i r a t i o n a l conclusions. First,

the Construction Industry has expressed an interest in hav­

ing a modern innovative management tool such as Value

Engineering be employed mor e often w ithin their industry.

In addition, the Construction Industry has a sincere

interest in being further educated on how t o implement the

Value Engineering methodology and techniques w ithin con­

struction.

The m o s t disappointing result of the survey was -how


little the industry knows, understands, and pays attention

to the importance of life cycle costs on construction pro­

jects. The C o n s t r u c t i o n Industry has passed this im portant

consideration back to the owner. However, general contract­

ing organizations are changing their views, and are begin­

ning to realize that they possess' the technology and natural

position w ithin a p ro ject's development to truly and effec­

tively study and provide the owner w i t h the valuable service

of Life Cycle Costing.


CHAPTER 4

ALTERNATIVE METHODS o f ECONOMIC ANALYSIS

AND CAPITAL BUDGETING

4_._1_ Introduction

The n e e d for economic comparison methods, which judge

and/or rank the feasibility of investments, has prompted the

generation of thousands of pages of research. In the follow ­

ing pages, methods of economic comparison and capital budg­

eting w ill be discussed. Generally accepted principles and

theories of the finance field w ill be presented. The Con­

struction and Design Industries have not yet fully accepted

these principles and theories of economic evaluation, which

has ultim ately resulted in less than optimal decision ma k ­

ing. The present methods utilized for economic evaluation

in Value Engineering, and the Design and Construction Indus­

try in general, w ill be discussed in Chapter 5. The

economic evaluation and ranking methods employed in these

t wo fields are sim ilar; however, they diverge on s ome basic

issues, which shall be p o i n t e d out.


113

Th e s y s t e m of Life Cycle Costing refers to those

economic analysis techniques which analyze the sum o f all

costs and b e n e f i t s of ownership throughout the useful life

of an i n v e s t m e n t , allowing for the tim e-value of money. The

tim e-value of mo ne y is created by the ability of the capital

requirement of an investment to have an e a r n i n g potential

with alternative investm ents, and is denoted by the discount

rate which w ill cause an i n v e s t m e n t , once discounted, to

satisfy this capital requirem ent.

Not all economic evaluation techniques are sym pathetic

to the tim e-value of money. Th e economic evaluation

methods, which ignore or improperly treat the tim e-value of

money, are referred to as Non-Life Cycle Costing methods.

4.1.1 After-Tax Cash Flows

G enerally, an i n v e s t m e n t may be e c o n o m i c a l l y evaluated

by performing an economic analysis on t h e projected cash

flows of the investment, as they are expected to effect an

organization. The projected cash flows of an investment

refer to the series of estim ated cash disbursements and

receipts which are expected throughout the economic life of

the inves tm en t.

The timing of the cash disbursements and receipts are

of particular interest, since Life Cycle Costing involves

the e v a lu a tio n of the tim e-value of money. Generally, all


114

cash transactions are assumed to take place at the end of

the year in which they actually took place. This assumption

does not apply for the initial cash investment, which is

assumed to have taken place at the end of the year zero.

The a f t e r - t a x cash flows, as opposed to accounting

flows or before-tax cash flows, are the proper flows to be

analyzed. This is true, since it is the after-tax cash

flows which represent most accurately how a n o r g a n i z a t i o n is

effected by a n i n v e s t m e n t . Accounting expenses, such as

depreciation, are considered to be paper flows and only

affect cash flows through their tax effects. Although

accounting expenses w ill determine the profitability of an

investment, it is the after-tax cash flows which truly

represent the new p o s i t i o n assumed by a n organization upon

acceptance of an i n v e s t m e n t .

Table 4.1 displays a generalized s u mm a r y of the after­

tax cash flows of an investment which should be considered.

The derivation of any given i t e m may be f o u n d in, 'C apital

B udgeting', by R o b e r t W. Johnson. [49] Nomenclature sim ilar

to that of Johnson's has been u t i l i z e d to ease referral back

to 'C apital B udgeting'. The presented table displays

results for both new i n v e s t m e n t s and retrofit replacement

investm ents. For an economic analysis of an i n v e s t m e n t , a

table sim ilar to Table 4.1 should be completed using actual

figures. By d e n o t i n g the timing and amount of the cash dis­

bursements and incomes, the table fully describes the


115

io

Ss
M
cd
0
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0
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116

after-tax cash flows of an investment,

where :

+ represents an i n f l o w or benefit,

represents an outflow or cost.

n is the economic life of the investm ent.

n' is the expected economic life of the item to be

replaced .

t is the y e a r in which working capital is required.

t' is the y e a r in which working capital is released.

Sq ' is the salvage value of the item being replaced in

the present year.

S /' is the salvage value of the item being replaced if

kept till n '.

Bq ' is the book v a l u e of t h e item being replaced in

the present year.

Bn , ' is the book v a l u e of t h e item being replaced if

kept till n' .

I is the cash cost for the investment in place.

Wt is other cash outlays necessitated by the invest­

ment that are not treated as part of the asset


acquired and are not expensed on t h e books.

is the cash outlays necessitated by the investment

that are expensed on t h e books.

is the a p p lic a b le income tax rate.

is the cash generated before taxes by a d d e d reve­

nues or reduced outlays as a result of the invest­

ment.

is the d e p r e c ia tio n in yeart of the proposed

inves tm en t.

is the funds freed from working capital in year t


th
(in this case the last or n year).

is the net cash realized from the sale of the

fixed asset in n year.

is the book v a l u e of the fixed asset at the time

of sale in the n tl1 y e a r .

is the applicable tax rate on capital gains and

assets .

is the depreciation in year t of the old depreci­

able asset to be replaced by p r o p o s e d capital

investm ent. The i n c l u s i o n of this term w ill

attest to the fact that in a replacement decision

the to ta ldepreciable term is equal to


118

+ X ( Dt - D,. ' ) . In other words, a depreciation

tax credit is foregone.

Another topic which needs to be explored, is the reali­

zation of a sunk cost. The p a s t costs of any alternative

are part of yesteryear and under no circum stances should

they be included in the estim ated cash flows of the

presently considered alternative, unless those costs w ill

affect future cash flow s. For example, an o r g a n i z a t i o n

which decides to build a factory might hire t wo design firms

to develop t wo d e s i g n s , which w i l l be competing against each

other. Design firm A is paid $30,000 for its design, which

is evaluated as requiring a total of $600,000 (not including

the design costs) for life cycle costs. Design firm B is

paid $10,000 for its design, which is evaluated as requiring

a total of $610,000 (not including the design costs) for

life cycle costs. If design costs are considered, firm A's

and B's designs w ill cost $630,000 and $620,000 respec­

tively, in which case, firm B's d e s ig n would be accepted,

and firm A's d e s ig n discarded. However, the design costs

are past costs and a r e considered to be s u n k costs, which

should be ignored. Once the design costs are considered as

sunk costs, the organization would realize that deign firm

A's design w ill save them $10,000.

It is not u n c o mmo n , in the Design-Construetion Indus­

try, for financing and interest costs to be figured into the


119

life cycle costing analysis as simply another cash flow.

However, this involves a serious conceptual error, since the

properly derived discount rate already considers these

interest payments. Financing costs are considered to be

part of the cost of capital and, as w ill be presented, the

weighted average cost of capital method u t i l i z e s these costs

when computing the proper discount rate. Including financ­

ing costs as a life cycle cost i n an econom ic analysis would

result in sub-optimal decision making. The object of an


economic analysis is to determine whether a project or

alternative is superior to others, and n o t which immediate

method of financing w ill be e m p l o y e d . As one professor of

finance states, "to be conceptually sound, our analysis must

consider the cash flows generated by capital investment pro­

posals separately from the cash outflows required to attract

the pool of funds justified by the investment opportuni­

ties." [50]

4.1.2 Capital Rationing and D e c i s i o n Making

If an organization has infinite funding at its dispo­

sal, economic analysis and e v a l u a t i o n would only be required

to prevent the acceptance of capital investments which would

not generate the income required to recover the initial cap­

ital expenditure and the cost of that capital, or to make a

choice between t wo or mo r e m utually exclusive investment

alternatives. A set of mutually exclusive or conflicting


120

investment alternatives exists where the acceptance of one

capital investment would n e c e s s i t a t e the rejection of the

rest of the set because they essentially satisfy the s a me

function . [51]

In certain atm ospheres, a series of investments may be

presented to an organization, o ne of wh ic h must be chosen

whether or n o t it produces a profit. For example, a factory

may be forced, by the Environmental Protection Agency's

regulations, to install a dust collecting system at the top

of its smokestack. The organization is forced to make a

choice among a l t e r n a t i v e s , such as a baghouse dust collector

or a wet scrubber, for reducing dust exhausted from its

smokestack. Neither alternative w ill generate profits.

However, the plant w ill be s h u t d o w n , which is considered

another alternative for evaluation, if it does not comply

with the Environmental Protection Agency's regulations. In

cases such as these, the objective of an ecqnomic analysis

is to minimize costs, rather than maximize profits.

In a u t o p i a n economic clim ate, an organization would

never be restricted by a lack of capital funds, if projects,

which returned both the required capital investment and its

cost, exist. However, this is not always the case. For

example, if an o r g a n i z a t i o n feels its stock is undervalued

by the market, it w ill postpone an issuance of stock until

the stock reaches an e q u i t a b l e value. Through a postponed

issuance, the organization will be lim iting its source of


121

capital, assuming it is already fully leveraged, which might

result in acceptable profit generating investments being

rejected or postponed.

The situation described above eventuates in many organ­

izations, and the restriction on capital funding is termed

capital rationing. An organization is forced to choose

among a set of independent profit generating projects in

order to seek out the set which w i l l not exceed the capital

funding available and w ill generate the optim al income

s tream .

Th e a b o v e descriptions of economic environments may be

combined and summarized in the following list:

1. Non-mutually exclusive proposals are available and no

capital rationing exists.

2. M utually exclusive proposals are available and no capi­

tal rationing exists.

3. Non-mutually exclusive proposals are available and cap­

ital rationing exists.

4. A mixture of m u t u a l l y and n o n - m u t u a l l y exclusive pro­

jects are available and capital rationing exists.

An o r g a n i z a t i o n requires a method of economic analysis,

evaluation, ranking, and com parison which w i l l choose the

optimal or set of optimal investm ents. The requirem ents of

this method a r e as follows:


122

- The m e t h o d must choose an i n v e s t m e n t ( s ) w h i c h produces

the optimal income stream.

- The m e t h o d s must be a b l e to properly evaluate and rank

investments in each of the four economic environments

listed above.

- The m e t h o d m u s t a c c o u n t for the tim e-value of money,

otherwise k n o wn a s the cost of capital.

4_. 2_ Discount Rate

Organizations attem pting to evaluate, according to

economic criteria, alternate methods of investment require a

discount rate. The derivation of the proper discount rate

for an o r g a n i z a t i o n is a very serious and c r i t i c a l exercise.

An o r g a n i z a t i o n which economically evaluates a set of alter­

natives utilizing an improper or inaccurate discount rate

could suffer potentially calamitous results. The discount

rate which an organization employs has t a k e n on various

names. For example, it has been r e f e r r e d to as a mi n i mu m

attractive rate of return (MARR), an o p p o r t u n i t y cost, a

cost of capital rate, and an i n t e r e s t rate. Whichever name

the discount rate is labeled with, it still refers to the

sa me object: the rate of return which an o rg anization's

assets must produce, in order to justify raising the funds

needed to acquire them. [52]


123

The d e f i n i t i o n of the discount rate is best justified

by e m p l o y i n g the t wo terms mi n i mu m a t t r a c t i v e rate of return

and c o s t of capital. Th e discount rate is the minimal

discount rate which needs to be satisfied in order to

breakeven with the cost required to raise the capital for an

organization.

4.2.1 Weighted Average Cost of Capital

An o r g a n i z a t i o n raises capital from many different

sources. However, all of the long term sources of capital

c a n be c l a s s i f i e d into one of the following categories: 1)

retained earnings, 2) long term debt, or 3) equity. In

order to determine the t o t a l cost of c a p i t a l for an organi­

zation, the total c o s t of capital foreach individual source

of long term capital must be determined. A weighted average

cost of capital for an organization is computed from these

individual costs of capital. The reason long term capital

is referred to rather than simply capital, results from the

assumption that an organization and potential investors con­

sider long term plans and p r o j e c t e d wealth expectations, and

not just simply daily, weekly, and yearly fluctuations.

The remainder of this section is devoted to the cata­

loging of a series of steps which s h o u l d be employed in

order to determine the weighted average cost of capital for

an organization. A complete derivation of t h e principles

and equations involved in this procedure can be found in


124

'Cost of C ap ital', by Wilbur G. Lewellen. [53] The s a me

nomenclature, as that of Lewellen, w ill be employed wh e n

presenting this procedure, in order to insure ease in refer­

ring back to 'Cost of C ap ital'.

The first step involves the determ ination of the

organization's growth rate. Since potential investors are

interested in the potential future dividends and increases

in the stock value of an organization, a growth rate for the

organization w ill need to be p r o j e c t e d . Th e annual growth

rate can be determined from e q u a t i o n 4.1.

g = x 100 (4.1)

whe r e :

g is a historical annual growth rate for an organi­

zation.

d^ is the dividends per share payment or earnings per

share in year i.

dQ is the dividend per share payment or earnings per

share in a selected base year.

is the number of years between the selected base

year and the year i.


125

The t wo p o i n t s of time in which d. and d are assumed


1 0

need to be cautiously chosen. Th e y should be chosen in typ­

ical or representative stable tim es. Short fluctuations in

the o rg an izatio n 's policy might adversely affect the calcu­

lated historical growth rate. It is advisable to calculate

many growth rates, utilizing different years, and choosing

the most representative growth rate based on present and

projected organizational policies.

Step t wo r e q u i r e s the determ ination of the discount

rate, which an i n v e s t o r may d e r i v e of future returns from an

organization. These returns can be resolved via t wo

separate methods. The first and most obvious means of

return on i n v e s t m e n t is through the payment of dividends by

the organization. The second means through which an i n v e s ­

tor benefits from the earnings of an o r g a n i z a t i o n i s. t h r o u g h

capital growth and, in turn, an i n c r e a s e in the value of his

investm ent. This discount rate can be determined by e m p l o y ­

ing equation 4.2.

di
K = + g (4.2)
o
whe r e :

K is the growth adjusted dividend yield or the

discount rate which an investor would derive from

future returns of an i n v e s t m e n t .
represents the current y ear's per share dividend.

Pq is the current market price being traded for the

org anization's stock.

g is the calculated historical growth rate computed

by E q u a t i o n 4.1.

The n e x t step requires the determ ination of the after­

tax discount rate, which the investing public applies to the

expected income streams generated by organizations which are

classified in the s a me risk class as the organization in

question. The a f t e r - t a x discount rate is calculated by

employing its relationship, as shown in equation 4.3, to the

growth adjusted dividend yield, K, which is determined using

equation 4.2.

r T
K = a + at - r) (1 - t c) D (4.3)
- v s J_
where:

at refers to the after-tax discount rate used by the

market to evaluate a level annual income s tr e a m of

the s o r t generated by f i r m s in this risk class.

r is the current annual interest rate the organiza­

tion would have to pa y its creditors for the bor­

rowing of long term debt.


127

t is the c o rp o ra te income tax rate of the organiza­

tion.

D is the t o t a l amount of long term debt of the

organization, expressed in current dollars.

Vg is the c u rre n t market value of the organization's

s tock.

By s e t t i n g Equation 4.3 equal to Equation 4.2, solving


for a^, and sim plifying the terms, Equation 4.4 is derived.

dl r D 1
1
P + 8 + ( 1 - tc ) V 1
0 s J (4.4)
°t = t D
c
1 +

Step four requires the development of the cost of capi­

tal for each individual source of capital funds. Equations

4.5, 4.6, and 4.7 represent the cost of capital for retained

earnings, long term d e b t, and e q u i t y .

( 1 - *p > (4.5)
’t ( ! - t g )

whe r e :

R„ is the cost of capital for the retained earnings

for an o r g a n i z a t i o n .

t is the proper personal income tax rate for the

o rg an izatio n 's stock owners.


128

t is the proper capital gains tax rate for the


m.
organization's stock owners.

R - a. ( 1 - t ) (4.6)
D t C

whe r e :

RD is the cost of capital for the long term debt of

an organization.

re = T ^ V ~ ( 4 - 7)
where:

R„ is the cost of capital for the equity of an o r g a n -

b is the percentage ga p between the theoretical and

actual proceeds realized when new s t o c k is issued;

it is the difference between the existing price on

the exchange and the net proceeds once the cost of

sale and the price differential used to complete a

speedy issue is deducted.

The fifth step requires a determ ination of the long

term capital structure of the organization. The long term

capital finance plan, as opposed to short fluctuating and

unrepresentative plans, should be s o u g h t out. Percentages

of retained earnings, long term debt, and equity of an


129

organization's long term capital structure should be calcu­

lated such that Equation 4.8 is satisfied.

XE + XD + XE ■ 1 < 4 - 8)
where:

X„ r e p r e s e n ts the percentage of the organization's

capital structure which is retained earnings.

Xp rep re sen ts the percentage of the organization's


capital structure which is long term d e b t.

X re p re s e n ts the percentage of the organization's


£
capital structure which is equity.

The w e i g h t e d average cost of capital for the organiza­

tion is computed in the sixth and f i n a l step of the pro­

cedure. By c o m b i n i n g the percentages and cost of capitals

of each individual source of capital, as shown i n Equation

4.9, the weighted average cost of capital may be computed

for an organization.

RA = (XR ) ( R R } + ( XD } ( RD } + ^ XE ^ ( R E ) ( 4 *9 )
whe r e :

R is the weighted average cost of capital for an


A
organization.
130

The p r o c e d u r e described above, for determ ining the

weighted average cost of capital, is widely accepted in

financial theory and in practice for private industry and

public utilities.

4.2.2 Public Finance

The cost of capital has proven to be a relevant

discount rate which private industry should employ in order

to properly evaluate proposed investm ents. However, govern­

mental branches and agencies do not issue stock or ke e p

retained earnings, and usually receive the bulk of their

budget from superior agencies' budgets at no cost. These

organizations usually have their appropriate discount rates

guided by m a n d a t e d or legislated requirem ents. [54]

A small percentage of agencies has the power to issue

debt, thereby creating a cost of capital. However, even

these agencies receive a large portion of their funds at no

cost from higher agencies. If a cost of capital is calcu­

lated for these agencies, it is likely that it w ill be

negligible, due to the minimal percentage of debt. Yet, the

government has adopted an i m p o r t a n t concept; all funds shall

be utilized productively. [55] In o r d e r to insure that this

concept is adhered to, a discount rate is employed in

evaluating public projects.


131

Th e t wo m o s t common m e t h o d s for arriving at a discount

rate which should be employed for economic evaluation of

public projects are as follow s:

1. I n t e r e s t s h o u l d be c h a r g e d a t t h e c u r r e n t r a t e at
which a particular g o v e rn m e n t a g e n c y can b o r ro w
m o n e y . The c h a r g e i s included, even though the
agency's projects are financed through c u rre n t
income. I f the u n c e r t a i n t y in h e re n t in estim ates
of future happenings is recognized at a l l , i t is
d o n e by a d o p t i n g a c o n s e r v a t i v e v a l u e for future
benef i t s .
2. I n t e r e s t s h o u l d be c h a r g e d a t a r a t e representing
t h e mi n i mu m a t t r a c t i v e r a t e o f r e t u r n . T h is would
be so me wh at higher than the cost of borrowed
money, in o rd e r to r e c o g n iz e the r i s k in v o lv e d in
a l l p r e d i c t i o n s of f u t u r e e v e n t s . The r a t e would
be set f o r each agency a f t e r r e p r e s e n t a t i v e p r o ­
j e c t s w h i c h p r o m i s e t h e b e s t u s e of ( u s u a l l y ) l i m ­
i t e d p u b lic funds a re a n a ly z e d . In any e v e n t , t h e
r a t e o f r e t u r n w o u l d be h i g h e n o u g h t o discourage
investments that do n o t a p p e a r a t t r a c t i v e i n t h e
l i g h t of f u t u r e u n c e r t a i n t i e s . [56]

4 . 3_ Non-Life Cycle Cos t i n g Methods

As d i s c u s s e d earlier, not all methods of economic

evaluation and comparison account for the tim e-value of

money. Moreover, s ome of these Non-Life Cycle Costing

methods have advantages and disadvantages associated with

them. Many a r e utilized regularly in private industry.

Several have no m e r i t or redeeming qualities what-so-ever.

These Non-Life Cycle Costing Methods, and their advantages

and disadvantages, are discussed on t h e following pages.


132

4.3.1 Simple and Discounted Payback Period

Simple payback period is a method of economic evalua­

tion which determines the amount of time required for an

initial capital investment to be f u l l y recovered through the

series of income returns generated by that investm ent. It

may be calculated by subtracting each successive y ear's net

benefits received from the initial capital investm ent. The

year i n which the initial capital investment is recovered

determines the payback period.

A discounted payback period may be a r r i v e d at by con­

sidering the tim e-value of money. Rather than simply sub­

tracting the annual net benefits from the initial capital

investment, this method requires the subtraction of the

present value of annual benefits. The discounted payback

period method of analysis provides a more accurate means of

comparison by i n c o r p o r a t i n g the cost of capital.

The drawbacks associated with these t wo methods are

obvious. First, the payback period method ignores the

series of cash flows subsequent to the payback period.

These flows are very important and significant, and it is

not apparent why an organization would purposely ignore

them. Second, the payback period method ignores the size of

the capital investm ent. Two a l t e r n a t i v e s may h a v e an ini­

tial size disparity of several significant digits, and the

payback period would n ot reveal it. For this reason, the


1'33

method s h o u l d be employed to determine liquidity of projects

rather than profitability of projects. Third, the simple

payback period method ignores the cost of capital or the

tim e-value of mo n e y relationship.

A survey of large industrial organizations, which wa s

performed in 1963, displayed that 64 p e r c e n t of the firms

sampled u t i l i z e d payback method as their sole method of

economic evaluation. In addition, another 18 p e r c e n t of the

firms used that method, supplemented by some other economic

method. [57] The w i d e s p r e a d application of this approach can

be a t t r i b u t e d to its three main characteristics. First, the

sim plicity of the approach allows management to understand

it very easily and quickly. Second, its calculations are

very sim plistic in nature and r e q u i r e a minimal time invest­

ment. Last, the approach recognizes the need for speedy

recovery of initial investment if that proves to be a n

important criteria. Whatever sim plistic characteristics

this method possess can hardly excuse its drawbacks and

inaccuraci e s .

4.3.2 Benefit-C ost Ratios

The benefit-cost ratio method of economic evaluation

enjoys widespread use w ithin the public section; particu­

larly within highway economy. The foundation of benefit-

cost ratio may be traced back to congressional legislation

from J u n e , 1936, wh e n C o n g r e s s stated, in the Flood Control


134

Act, that a project should be p r o m u l g a t e d only if the bene­

fits, to whomever they may a c c r u e , are in excess of the

estim ated costs. [58] The benefit-cost ratio is best

expressed in Equation 4.10. [59]

R —R
t, . annual b e n efits 1 ,, . „ N
B/ C r a t i o = -------------- :--------- = r=-------- — (4.10)
annual cost - H

whe r e :

R is the total annual user cost for the basic condi­

tion or existing one, or for that alternative of

lower first cos t .

R^ is the total annual user cost for a proposed

improvement, or for that alternative of higher

first cost.

H is the total annual cost for the basic condition

or existing one, or for that alternative of lower

first cost.

is the total cost for a proposed improvement, or

for that alternative of higher first cost.

This approach requires that a mi n i mu m attractive

benefit-cost ratio be assigned. For each alternative a

benefit-cost ratio is calculated. Those alternatives which

fall short of the mi n i mu m a t t r a c t i v e benefit-cost ratio are

discarded. The benefit-cost ratio for each increm ental


135

investment is then performed for the remaining alternatives,

which are ordered from lo w e s t to highest according to ini­

tial capital investm ent. The h i g h e s t initial cost alterna­

tive for which the increm ental benefit-cost ratio exceeds

the mi n i mu m a t t r a c t i v e benefit-cost ratio is presumed to be

the most acceptable plan.

The benefit-cost ratio has been referred to as the pro­

fitability index, savings-investm ent ratio, or excess

present value index in the financial field and private

industry. [60] In most cases the mi n i mu m attractive

benefit-cost ratio is assigned a value of 1.0, and the ratio

usually consists of the present values of benefits and

costs. In s ome p u b l i c agencies, where benefits are measured

as a function of user benefits, the tim e-value of mone y is

only applied to the denominator, or costs.

A simple calculation of the discounted benefit-cost

ratio may be used to discard unacceptable projects. How­

ever, in order to properly rank competing investment alter­

natives, incremental benefit-cost ratio analysis, sim ilar to

the incremental rate of return analysis, yet to be

explained, must be e m p l o y e d .

Several drawbacks may be a c c r e d i t e d to the benefit cost

ratio method. First, the method forces classification of an

item as a cost or benefit, which c a n be a dubious decision

at best. For exa m ple, if a new p a v e m e n t surface was being


136

sought, and o ne of the alternatives reduced maintenance

costs, a p ro b le m would e x i s t with the classification of the

reduced maintenance costs. The reduced m aintenance cost

could be classified as a benefit (numerator) or as a nega-


X + Y
tive cost (denom inator). Since ------ ^ not equal to
£
—^—— - —, the economic evaluation using the benefit-cost

ratio method is very much d e p e n d e n t on a s t r i c t classifica­

tion of benefits, costs, negative benefits, and negative

costs.

A second drawback exists in that benefit-cost ratios

are used with poor consideration of the discount rate.

Often highway and other public projects w ill result in user

benefits alone, which are not discounted. Therefore, only

the denominator, or cost, is discounted. In these cases,

the value of the benefit-cost ratio is severely dependent on

the value of the discount rate used to determine the present

value of the benefits. A unit value percentage differen­

tial could determine whether a project is discarded or

slated for construction.

A third drawback, which applies to simple benefit-cost

ratios, is that the approach, like the simple payback

method, totally ignores the tim e-value of mo n e y relation­

ship.

A fourth problem is that a benefit-cost ratio alone

does not evaluate the initial capital investment size


137

disparity among different projects. For this reason, the

method should be e m p l o y e d to determine liquidity of projects

rather than the profitability of projects.

If projects in which benefits and costs are strictly

defined, and the discount rate has been arrived at using the

proper principles, such as the w eighted average cost of cap­

ital method, the benefit-cost ratio method may be e m p l o y e d

to discard unacceptable projects. In a d d it io n , the incre­

mental benefit-cost ratio method, which absorbs the size

disparity problem mentioned earlier, may be u t i l i z e d to suc­

cessfully rank the remaining acceptable projects.

4.3.3 Accounting Rate of Return

Th e s a me s u r v e y w h i c h wa s u s e d to evaluate the use of

the payback method w ithin private industry, revealed that

almost 15 p e r c e n t of the sampled organizations utilized s o me

form of the accounting rate of return method. This

approach, otherwise k n o wn a s the average rate of return

method or financial statem ent method, encompasses as many

different choices of com putational procedures as it has

labels. Th e m o s t common a p p r o a c h e s include calculating the

ratio of accounting reported profits to either the initial

outlay or the average book value investm ent. [61] The

accounting reported profits are those profits reported on a n

o rg an izatio n 's financial statem ents, such as the profit

sheet and the income statem ent. These profits are annual
138

earnings after depreciation deductions and after taxes. The

average book v a l u e investment can be calculated as shown in

Equation 4.11. [62]

1 + St
c = s — + 0 (4.11)
i- c
whe r e :

c is the average investment for the alternative.

I is the in itia l capital expenditure for the invest­

ment .

St is the salvage value for the investment.

0c is the working c a p i t a l required for the invest­

ment.

The accounting r a t e of return method of economic

evaluation owes its use by p r i v a t e industry t o t wo basic

characteristics. F i r s t , the approach requires a few

sim plistic computations involving data already provided by

the o rg an izatio n 's financial statem ents. Second, the data

and terminology required by t h e method are very fam iliar to

accountants, who a r e usually involved in the financial deci­

sion making process for organizations.

The s h o r t c o m i n g s of this approach are obvious. First,

the approach completely ignores the actual benefits or cash

flows of an investm ent. Differences in depreciation


139

schedules for competing alternatives may h a v e a major effect

on t h e computed accounting rate of return. Second, the

approach disregards the tim e-value principle of money.

Third, in certain cases, the approach, depending on t h e use

of initial investment or a v e r a g e investment as the denomi­

nator, w ill yield different results. Another major

shortcoming is that the approach ignores the size disparity

p r o b l e m as discussed previously. This im plies, as in the

prior t wo cases, that the method should only be e m p l o y e d to


determine the liquidity of a project.

Considering all these failings, employment of this

technique can hardly be advocated. The results are con­

flicting and u n p r e d i c t a b l e . However, it has been a c c r e d i t e d

with some success whe n i m p l e m e n t e d in a c o n s is te n t intracom ­

pany hindsight mode. Th e data which the method requires are

in the s a me form as profit statem ents reported on the capi­

tal investment once it has already been term inated.

4_.4_ Life Cycle Costing Methods

Several economic evaluation methods, which are sim ilar,

yet unacceptably divergent, to life cycle costing methods,

have already been discussed. For the most part, all of

these, with the possible exception of the incremental

benefit-cost ratio method, fail to meet the required cri­

teria of a true economic evaluation and ranking method,

which were numerated earlier. One method exists which


140

properly meets all of the required criteria. Another method

exists which meets all of the criteria if used with caution.

These t wo m e t h o d s are titled net present value analysis and

incremental rate of return analysis, respectively. Very

much related to net present value analysis is equivalent

annual value analysis. A brief presentation of these three

methods follow s.

4.4.1 Net Present Value Analysis

Ne t present value analysis involves the discounting of

all pertinent cash flows for proposals t o be evaluated at

the end of year zero. The p r e s e n t value of af u t u r e cash

flow c a n be calculated, as shown i n Equation 4.12.

P = F ( 1 + i )"n (4.12)

whe r e :

(1 + i ) n i s the single payment present worth f a c t o r .

P is thepresent value, at the end of year zero, of

a future cash flow.

F is the future value, at the end o f year n, of a

cash flow.
t

i is the discount rate.


141

n is the number of years the cash flow is being


I dis counted

The p r e s e n t value of an a n n u a l uniform series, which

begins at the end of the first year of cash flows, can be

calculated as shown i n Equation 4,13.

( 1 + i )n - 1
P A (4.13)
i ( 1 + i )n
whe r e :

( 1 + i )n - 1~|
| is the uniform series present worth
i ( 1 + i )n J
factor .

P is the present value, at the end of year zero, of

4 uniform annual series of cash flows, which begin

at the end of the first year.

A is the value of each of the uniform annual cash

flows, which begin at the end of the first year.

U tilizing Equations 4.12 and 4.13, a series of cash

flows for an investment can be discounted to the present

tim e. By e x p r e s s i n g the cash flows in equivalent values,

both the liquidity and profitability of an i n v e s t m e n t can be

seen. If the economic analysis involves a fixed input, the

objective would be to maximize the present value of bene­

fits. If the economic analysis involves a fixed output, the


objective would be to minimize the present value of costs.

If neither the input or output is fixed, the objective would

be to maximize the net present value, which is described in

Equation 4.14.

NPW = ( PVv - PV ) (4.14)


b c
whe r e :

NPW is the net present worth of an i n v e s t m e n t .

PV, is the present value of the benefits of an invest-


b
ment.

PV^ is the present value of the costs of an invest­

ment .

When an o rg an izatio n 's economic c li m a t e does not

include capital rationing, the objective of net present

value analysis is to accept all projects which have a net

present value (NPV) larger than zero. If a decision between

t wo m u t u a l l y exclusive projects is needed, the objective is

to choose the alternative with the l a r g e s t net present

value .

If the organization experiences a restriction on capi­

tal funding and proceeds to employ capital rationing, net

present value analysis can still be used successfully. If

all projects were non-mutually exclusive and independent


143

projects, than a net present value analysis on all possible

combinations of projects, withthe constraint of initial

capital budgeting, should be employed. The objective of

economic ranking is to maximize the net present value of the

set of projects.

If a mixture of non-mutually exclusive and mutually

exclusive projects exists in the s a me environment of capital

rationing, the objective is to maximize the net present

value on all possible combinations, with t wo constraints.

The f i r s t constraint is the available initial capital fund­

ing lim itations. The s e c o n d i s the m utually exclusive rela­

tionship among a subset of t h e projects. The decision

between t wo m utually exclusive projects should not be made

in an e n v i r o n m e n t of capital rationing. Instead all choices

should be considered as part of the final set to choose

f r o m.

Net present value analysis w ill always prove to be an

acceptable and successful method of economic evaluation and

ranking if employed using the proper objectives and con­

straints mentioned above.

4.4.2 Equivalent Uniform Annual Value Analysis

Equivalent uniform annual value analysis is another

method of economic analysis, which can be u t i l i z e d to per­

form economic evaluation and ranking, and which is very


144

sim ilar to net present value analysis. This method of

analysis involves the representation of benefits and costs

of a proposal as a series of equivalent uniform annual

values.

A present s um o f mo ne y may be equated to a series of

uniform annual cash flows, as displayed in Equation 4.15.

i ( 1 + i 1
A = 1 I - * 1 ; 1 (4.15)
_ ( 1 + i ) n -1 J
whe r e :

i ( 1 + i )n
----------------------- ------1 i s the capital recovery factor.
( 1 + i ) n -1 J

is an e n d - o f - p e r i o d cash receipt or disbursement

in a uniform annual series continuing for n

periods, which is equivalent to a present sum of

money, p, at a discount rate, i.

A future sum o f mo ne y may be e q u a t e d to a series of

uniform annual cash flows, as shown in Equation 4.16.

A = (4.16)
( 1 + 1 ) - 1
( 1 + 1 )'
145

whe r e :

is the sinking fund factor.


( 1 + i ) - 1

A is an e n d - o f - p e r i o d cash receipt or disbursement

in a uniform annual series continuing for n

periods, which is equivalent to a future s um of


money, p, at a discount rate, i.

The n e t equivalent uniform annual worth of a proposal

may be e s t a b l i s h e d , as shown i n Equation 4.17.

NEUAW = EUAB - EUAC (4.17)

whe r e :

NEUAW i s the equivalent uniform annual worth of a pro­

posal .

EUAB i s the equivalent annual benefit of a proposal.

EUAC i s the equivalent annual cost of a proposal.

The m e t h o d and objectives of net equivalent annual

worth analysis, in all four of the different economic

environm ents, are identical to those already described for

net present worth analysis.


146

However, this analysis is superior to net present worth

analysis, in one dimension. Ne t equivalent uniform annual

worth analysis provides a mo r e sim plistic method of analyz­

ing proposals with unequal lives. Assuming that the propo­

sals were being considered for perpetual use, net present

worth analysis would require the calculation of the net

present value of both alternatives over a period, which

represents a common m ultiple between the u s e f u l lives of

both proposals. For example, if one proposal has a useful

life of eight years and another of nine years, then the

period of analysis for a net present worth analysis would be

72 y e a r s . This assumes that the proposals would be required

for 72 y e a r s . If this assumption is considered to be an

erroneous one, then the analysis should consider only the

replacement of each p roposal for the useful life of the pro­

ject and assume a reasonable salvage value for the remaining

useful life of each proposal. By e m p l o y i n g net equivalent

uniform annual worth analysis, the procedure is sim plified,

since the method considers annual costs as opposed to col­

lective useful life costs.

As d i s c u s s e d above, net equivalent uniform annual worth

analysis is superior to net present worth a n a l y s i s in the

instance of u n e q u a l lives. However, in every other respect,

the t wo methods are equivalent and, even in the case of

unequal lives, the methods w ill always yield identical

results.
147

4.4.3 Discounted Rate of Return Analysis

Discounted rate of return analysis exists as a common

method of economic evaluation and ranking w ithin private

industry. By m a n y , it is felt that representing a proposal

by its rate of return w ill make it easier for management to

comprehend the analysis. Th e a c c e p t a b i l i t y of a proposal is

determined through a comparison of the rate of return to the

mi n i mu m a t t r a c t i v e rate of return (MARR) established by


management. The mi n i mu m attractive rate of return, by

definition, is the cost of capital. Therefore, if a

p ro ject's rate of return is less than the mi n i mu m a t t r a c t i v e

rate of return, the project is unacceptable and should be

discarded.

The rate of return is calculated by d e t e r m i n i n g at what

interest rate the net present worth of a project is equal to

zero. Several procedures, such as trial and error, or

graphical methods, can be employed to ease the pain of this

calculation. In the case of no c a p i t a l rationing and non-

m utually exclusive projects, all projects with a rate of

return greater than the mi n i mu m a t t r a c t i v e rate of return

would be accepted. However, whe n m u t u a l l y exclusive pro­

jects are being considered, the rate of return suffers from

the initial capital size disparity problem discussed ear­

lier. U nfortunately, rate of return analysis is a one

dimensional measurement. It does not describe o ne very

important dimension, the size of the capital investm ent.


148

However, this initial capital size disparity problem can be

overcome by e m p l o y i n g incremental rate of return analysis.

Incremental rate of return analysis, as described in

Figure 4.1, analyzes the rate of return on the differential

increment of initial capital expenditures between t wo a l t e r ­

native proposals. If this increm ental rate of return is

greater than the mi n i mu m r a t e of return, then the additional

benefits generated by the larger initial capital investment

constitutes an a c c e p t a b l e •p r o p o s a l .

In the case of capital rationing, the rate of return

analysis must be p e r f o r m e d on a l l possible combinations of

projects, with the proper c o n s t r a i n t s being abided by. In

the next section, the rate of return method w i l l be compared

and contrasted with the net present value method of

analysis. Some very serious and conceptual errors w ill be

presented.

4.4.4 Ne t Present Value Analysis vs. Rate of Return

As discussed previously, both the net present value

analysis and the rate of return analysis are prominent

methods of performing economic ranking and evaluation. Both

methods seem to satisfy all the requirem ents of the life

cycle cost system. However, the r a t e of return method, as

w ill be displayed, is an u n a c c e p t a b l e a n a l y s i s method.


149

COMPUTE RATE OF RETURN


FOR ALL INVESTMENTS

DISCARD ALL INVESTMENTS


WHICH ROR < MARR

RANK REMAINING INVESTMENTS


IN ORDER OF
INITIAL CAPITAL REQUIRED

COMPUTE RATE OF RETURN OF


INCREMENTAL CAPITAL
REQUIREMENT OF SUCCEEDING
INVESTMENT OVER PRECEEDING
In v e s t m e n t

DISCARD
IS INCREMENTAL RATE OF INVESTMENT
RETURN > MARR

NO
YES

IS THIS THE LAST


PROPOSAL
NO YES

THE END

Figure 4.1 Incremental Rate of Return Analysis


150

Rate of return analysis, as already discussed, fails to

recognize the initial capital size disparity, which forces

an organization to employ the mo r e tedious and complicated

method of incremental rate of return analysis. However, as

R. W. Johnson demonstrates in "Capital Budgeting", the

entire rate of_ return method fails to recognize a time

disparity problem. Th e time disparity problem can not be a s

easily detected as a size disparity problem, although it is,

in effect, a special case of the size disparity problem.


[63] For example, consider t wo p r o j e c t s which have an e q u a l

capital expenditure requirem ent, but result in different

cash inflows, as shown i n Table 4.2.

Table 4.2 Ti me D isparity Example

Initial Ca s h Inflows NPV Discounted


Project Capital R a t e of
Expenditure Year 1 Year 2 2 5% Re t u rn
A $ 1 , 000 $1 , 0 6 5 $435 $1 130 38%
1
---- 1
</>

O
I O

B $ 1 ,000 $200 $1 136 34 .2%

Depending on w h i c h method of analysis is employed, the

choice of which project w ill make optimal use of the initial

capital expenditure of $1,000 is conflicting. The query

encountered here has been defined as the time disparity

problem and w i l l be explained below.

Consider the projects as either being mutually

exclusive or existing in a period of capital rationing.

Whatever the case, consider the t wo p r o j e c t s shown in Table


4.2 as competing against each other. A cash flow diagram

describing both projects is displayed in Figure 4.2. At the

end of the first year, project A accumulates $1,380, of

which $1,065 is withdrawn from the project, to be reinvested

in projects with a rate of return of an u n k n o w n v a l u e x% ,

and $315 remains invested in the project at the p ro je c t's

38% r a t e of return. At the end of the first year, project B

accumulates $1,342, of which $300 is withdrawn from the pro­

ject, to be reinvested in projects with a rate of return of

an unknown v a l u e x%, and $1,042 remains invested in the pro­

ject at the p ro ject's 34.2% r a t e of return.

In a d d i t i o n , Figure 4.2 demonstrates that the cash

flows for each project are equivalent to t wo d i f f e r e n t

amounts of cash invested at different rates for a period of

one year. The first is invested at the rate of return of

the project, and the second is invested in additional pro­

jects at s ome rate of return x%. Investors who p u r c h a s e the

stock of an organization do s o on t h e basis that the company

w ill invest their funds in projects which w i l l yield a rate

of return equal to the cost of capital. Moreover, by a s s u m ­

ing that wh e n the funds of a project are released they w ill

be reinvested in projects at the cost of capital, x is set

at 25%. If the funds are reinvested in projects yielding a

25% r a t e of return, the total earnings of projects A and

B, as shown in Figure 4.2, w ill be $1130 and $1136

respectively. In this case, project B is the superior


152

END OF END OF END OF


PROJECT YEAR 0 YEAR 1 YEAR 2

— ► $1,065 9 X% ► $1,065 (l*x)

$1,000 » 38% -------------- ► $1380

-► $315 9 38% ----------- ► $035

► $300 9 x% ► $300 (l«x)

$1,000 9 30.2% ► $1302

$1J302 9 30.2%-----------► $1,000

EQUIVALENT TO:

A $315 x 138 x (P/F3/25%) * $11365 x (1* x) x(P/F,2,2S%)

B $11302 x 1302 x (P/F3<25%) * $300 x (1* x) X<P/F335%)

IF x - 25% FOR REINVESTED FUNDS;

TOTAL RETURN

A $035(.60) * $1J65 (135X.60) - $278 * $852 - $1130

B $1,000060) ♦ $300(135X.60) - $896 *$200 - $1136

Figure 4.2 Ti me D i s p a r i t y Explanation

f
153

alternative, which may be a c c r e d i t e d to the fact that alter­

native A has a larger sum of money i n v e s t e d at a lower

discount rate than project B.

A summarization of the objectives and p r o p e r methods of

employing either the rate of return method or the net

present value method of analysis for economic decision ma k ­

ing is displayed in Figure 4.3. Although the size disparity

problem of the rate of return method can be easily recog­


nized and alleviated, by e m p l o y i n g the very complicated and

burdensome increm ental rate of return method, the time

disparity problem can not be e i t h e r easily recognized or

alleviated. The net present value method and the equivalent

uniform annual value method are both i mmune to the t wo p r o b ­

lems described above. These t wo methods accurately and

clearly display the new p o s i t i o n assumed by a n organization,

whereas the rate of return method does not.

4_.5_ Other Economic Topics

Several other topics, which may have major ram ifica­

tions on t h e development of an a c c u r a t e economic evaluation

or comparison, need to be e x p l o r e d . These topics include:

the effects of inflation and escalation, the consequences of

further tax considerations, integer and linear programming

applications, and long term capital budgeting.


154

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Another topic of major significance involves the uncer­

tainty, risk, and sensitivity associated with the estim ation

of future cash flow s. The s e r i o u s n e s s of this topic can not

be overemphasized. Therefore, Chapter 9 is totally devoted

to the topic.

4.5.1 Inflation and E s c a l a t i o n E ffects

For any economic analysis to be considered complete, it

must be able to properly and accurately represent the

effects of inflation and escalation. Inflation is described

as a rise in the general price level of items to be p u r ­

chased, or, put another way, a decline in the general pur­

chasing power of the dollar. Escalation, on t h e other hand,

is described as the difference between the general rate of

inflation and the rate of increase for a given item of - c o s t ,

such as energy. [64] Whatever the case may b e , either infla­

tion or escalation, a complete economic analysis must yield

to its effects.

Table 4.3 displays a summarization of t wo methods of

incorporating the effects of inflation and/or escalation.

[65] where:

r^ is the general annual rate of inflation.

r is the annual rate of escalation of a cost item,


e
above or below the general annual rate of infla­

tion.
156

>%
p
CO p
c d
o d
*H o
P o
CO CO
<N rH •H <u >»
<P CO T3 c fC fO fO
3*s d p •rH p <U CU
o rH <u 0) <u p 0) p
H
a CO A CO g CO •H CO CO
'O
o c CO
VP *P 0) a CO CO P CO +
QJ 1
X 0 MH •H p •H CO a) <u P
p Id g CO CO p p •H ♦H
o (J
CU d p E o u P P
Effects

X 0 c 0) d c d
H M M
•H 04
CO CO
d
rH <U
o CO
d 1=)
H
Escalation


P
CO
d
o p
•H c
And

P d
CO o >*
f"H rH a >. 0) HO X
«P CO CO p HO •c
p •H p 0)
Inflation

d <U
H o T3 a) CU CO CO
’“0 <U A CO •H CO £ CO CU CO (U
0 cp Ip rH a) CO P d CO CU p <u p
X 0 'p CO p 0) •H CO P p
JJ Id <U CO p CO u u
0) d P p o £ d CU
£ o 0) 0) M Q
•H CO a 04
CO
of

d 0)
rH CO
O
A Summary

X
Id

fC /—N .C /—v
CO •H CO •H CO •rH
fC co P co P CO P
O P CO a CJ o
c
4.3

•H CO CO CO II /\ V
E g d CU CJ ? <U N
—/ a) 0) v—/
0 0) o p 0 rH rH rH
c p u CO T3 rH XJ CO fO CO -Q CO
0 M 3 3 3
Tabl e

CO 04 <U PH CO CO CO
o •rH X •H o •H o •H o
Id Q P rH P rH p rH
&H CO Oh CO Ph CO pH
> > >
is a real discount rate reflecting the cost of

capital.

i is a nominal discount rate reflecting the cost of

capital and inflation effects.

The first method, summarized in Table 4.3, ignores the

inflationary effects on f u t u r e cash flow s. V ariable costs,

which would feel sim ilar effects as the inflation rate would

predict, should remain in constant year zero dollars. Vari­

able cash flow s, which feel effects different than those

predicted by the general inflation rate, should be adjusted

for the effects of d i f f e r e n t i a l escalation only. These

effects can be e i t h e r positive or negative, depending on

whether the escalation is above or below the general infla­

tion rate. Cash flows which w ill remain constant, resulting

by contract or s o me other non-inf lationary effected agree­

ment, s h o u l d be adjusted downward, since their purchasing

power w i l l decrease as a result of future inflation. If all

of the aboveg u i d e l in e s are abided by, all the cash flows

may be evaluated for tim e-value effects by employing the

real discount r a t e , which has been r e f e r r e d to simply as the

discount rate up to t h i s point.

Th e s e co n d method recognizes all the inflationary

effects on future cash flow s. Variable costs, which would

properly r e f l e c t the general inflation rate, should be

adjusted to do s o . Variable effects, which would increase


158

prices at a differential escalation rate above or below the

general rate of inflation, should be a d j u s t e d to reflect

their proper in c re a s e . Constant flows should remain con­

stant. This method requires the use of a nominal discount

rate, which represents both the real discount rate and the

inflation effects, as shown i n Equation 4.18.

i = i + r . + i r. (4.18)
n r i r i

This formula is derived from the principal that infla­

tion effects are sim ilar to the tim e-value of money, and can

be represented by E q u a t i o n 4.19.

F - F' ( 1 + r )"n (4.19)

whe r e :

F is the future amount of benefits or costs in year

n expressed in year zero dollars.

F' is the future amount of the benefits or costs in

an inflationary period.

In the special case wh e n a l l cash flows are considered

to be variable flows, which w i l l deviate at a rate sim ilar

to the predicted inflation rate, the economic analysis may

employ the real discount rate and totally ignore the effects

of inflation. Th e topic of predicting future inflation and

escalation rates is beyond the scope of this research

effort. However, the situation described above is not as


f
remote as it may s o u n d . Landlords are presently experienc­

ing an alm ost identical situation. It is not u n c ommon for

them to include clauses in their leases, such as the one in

Figure 4.4, in which they attempt to protect their future

income from the effects of inflation by a d j u s t i n g the rent

annually with a formula which utilizes an index which

assim ilates the inflation rate. [66] This, in effect, forces

leasees to pay a v a r i a b l e rent which inflates at a rate

sim ilar to the general inflation rate of the costs the les­
sor experiences. However, even in this case, there are t wo

exceptions to experiencing a situation with perfect varia­

bility of costs and benefits. First, the energy costs w ill

probably inflate at a different rate than the general rate

of inflation, thereby requiring an a d j u s t m e n t for the dif­

ferential escalation. Second, the tax benefits experienced

as a result of depreciation w rite-offs are i mmune to the

effects of inflation, thereby requiring an a d j u s t m e n t to

reflect their depletion in value.

When a s e r i e s of cash flows are expected to inflate at

a rate higher than the general inflation rate, such as

energy costs in the above example, a sim pler method of

evaluation in place of the one r e c o m m e n d e d may be employed.

By c o n s i d e r i n g the real discount rate of method 1 as a nomi­

nal one, to account for escalation, a real (for escalated

cash flows) inflation rate, as shown i n Equation 4.20, may

be derived from E q u a t i o n 4.19.


16 0

44. CONSUMER PRICE INDEX

The t e n a n t a g r e e s t h a t f o r e a c h y e a r of the term of


this lease a nd e a c h y e a r of any e x t e n s i o n s o r r e n e w a l
h e r e o f , t h e a n n u a l r e n t s h a l l be a d j u s t e d by u s i n g any
increase o r d e c r e a s e i n t h e CONSUMER PRICE INDEX, U . S .
CITY AVERAGE FOR ALL URBAN CONSUMERS, a s published by
the U.S. DEPT. OF LABOR, w i t h t h e i n d e x f o r t h e f i r s t
month of t h e o r i g i n a l t e r m of t h i s l e a s e as t h e b a s e t o
compute the c h a n g e f o r e a c h y e a r of t h e l e a s e and a n y
e x t e n s i o n s or r e n e w a l s h e r e o f , except that the rent
shall never be l e s s t h a n t h e b a s e r e n t p l u s a l l o t h e r
i n c r e m e n t s a s p r o v i d e d by t h e l e a s e . Th e CPI increase
shall be c o m p u t e d a t t h e e n d o f e a c h c a l e n d a r y e a r a n d
s h a l l be b i l l e d a s A d d i t i o n a l R e n t a s f o l l o w s :

ADD' L RENT CPI - p PI end of year - B a s e CPI x Base Rent


|_ B a s e CPI

In the event that the CPI is not p u b l i s h e d in i t s


c p r e s e n t form or a t a l l , th e most s i m i l a r successor or
s u b s t i t u t e i n d e x p u b l i s h e d by t h e F e d e r a l G o v e r n m e n t o r
n o n - p a r t i s a n p u b l i c a t i o n , b a s e d on o r a d j u s t e d t o con­
form to the i n f o r m a t i o n used in d e t e r m i n i n g the p r e s e n t
C P I , s h a l l be u s e d . All a d d i t i o n a l rent payable under
other provisions o f t h i s l e a s e s h a l l be p a i d i n a d d i ­
t i o n t o t h i s a d j u s t m e n t of t h e b a s i c a n n u a l r e n t .

Figure 4.4 A Typical Rent Adjustment Clause

f
161

i - r
i = ------ — (4.20)
e 1 + r
e
If r = i than P= F o r P= A n .
e r
whe r e :

i is a discount rate, which may be used in the

present value formulas for a single or a series of

variable future cash flows, which incorporate the

effect of an e s c a l a t i o n and time value effect.

The employment of the escalation adjusted real discount

rate elim inates the need to adjust a series of uniform

annual variable cash flows for escalation effects, as

required by method 1. This procedure may be u t i l i z e d to

overcome cumbersome calculations whe n evaluating variable

cash flows such as energy costs, which inflate at a dif­

ferent rate than the general rate of inflation. Tables may

be found in recent economic research which display time-

value and escalation adjusted present worth factors.

An e a s i e r method of measuring the tim e-value and infla­

tion effects of constant cash flows, such as tax benefits of

depreciation or contractual obligations which are not infla­

tion protected, is to switch from method 1 to method 2

analysis. Rather than decreasing the value of the tax

credit annually, it remain's constant, and the nominal

discount rate as described in Equation 4.18 is employed to

calculate present values.


Whichever method is utilized to evaluate inflation and

escalation effects on e c o n o m i c evaluations and ranking, it

must be e m p h a s i z e d that the prediction of inflation and

escalation rates are only estim ates, and the inclusion of an

improperly predicted rate might adversely effect the

economic evaluations and/or rankings.

4.5.2 Other Ta x C o n s i d e r a t i o n s

In 1981, the United States Congress enacted the Ec o n o my

Recovery T a x Ac t of 1981. This act included provisions for

such items as: a new depreciation system, investment tax

credits, carryover periods, and more. These new t a x rules

have an i m p o r t a n t impact over most economic analyses. As a

result of the tax co nsideration's characteristics, lack of

brevity and sim plicity, and the constant prediction of new

revision amendments, it is beyond the scope of this research

effort to present all of the tax considerations which need

to be e v a l u a t e d during an economic analysis .

The t wo most important concerns of an economic

analysis, pertaining to building design and construction,

are the Accelerated Cost Recovery System (ACRS) and the

investment tax credit. In order to insure accuracy i n an

economic investigation, the team p e r f o r m i n g the investiga­

tion should consult United States Internal Revenue Service

publications and/or recent tax accounting textbooks. How­

ever, even these sources can not be used to project


163

reasonable interpretations. For example, the investment tax

credit disqualifies buildings and their components as pro­

perty which c o me s under the effects of the investm ent tax

credit benefits. An i m p o r t a n t interpretation is required in

order to determine whether an e l e v a t o r or the equipment for

a m anufacturing line, which are moving parts w ithin a build­

ing, classify asb u i l d i n g components. Questions such as

these ma ke it im p o ssib le to perform an a c c u r a t e economic

investigation without the consultation of a qualified tax

expert on t h e pertinent tax considerations.

4.5.3 Economic E v a l u a t i o n Period

In order to p e rform an economic analysis, a period dur­

ing which all cash flows should be considered must be deter­

mined. This period has been referred to as an economic

and/or useful life. In fact, these t wo terms have t wo

separate meanings. Economic life refers to the period of

time over which a proposal is needed by a n owner. Useful

life refers to the period of time over which a proposal w ill

continue to operate or generate income. For example, con­

sider a organization which chooses to take bids for the con­

struction of a factory. This factory w ill produce a new

technological product, which the organization feels w ill be

dated quickly and should not be p r o d u c e d after three years.

Unless the organization proposes a plan for different occu­

pation of the factory in three years, the economic life of


164

the project is three years. However, a building usually w ill

stand longer than three years. If this building could stand

twenty years of occupation without any major renovations,

the useful life of the factory would be twenty years.

A decision as to which period, the economic life or the

useful life, should be e m p l o y e d wh e n p e r f o r m i n g life cycle

cost analysis on building components and designs is

required. Many w o u l d a r g u e that if the factory w ill provide


this organization with benefits for only three years, then

the economic analysis should only consider a three year

period. However, if the building w ill be sold at.that time

at fair market value, then the period of analysis should be

expanded to include a twenty year period. This is the

direct result of an a ssu m p tio n that a prospective owner w i l l

purchase, the building based on i t s life cycle value. It is

a well founded assumption that an owner would value a build­

ing higher if it promised life cycle costs which were rea­

sonable or better than most b u ild in g 's life cycle costs.

If the original organization does not feel that it

would be able to regain a salvage value equivalent to the

incremental investment needed to lower life cycle costs for

a twenty year period, it may d e c i d e to u t i l i z e the three

year period and assume reasonable salvage values at the

three year period. The decision w ill still incorporate

whether or not a better design, which produces long term

life cycle savings, w ill be welcomed and valued by a


165

prospective buyer in three years.

4.5.4 Integer and Linear Programming Applications

As d i s c u s s e d previously, if an organization or a team

has a number of proposals to choose from i n a period of cap­

ital rationing, in order to select the optimal set of propo­

sals, the net present worth of each and e v e r y possible set

is required. The calculations involved can prove to be

quite tedious and cumbersome. However, the p r o b l e m may be

represented in a mathematical model, and computer software

may be utilized to aid in arriving at the solution. The

mathematical models are integer and linear programming, and

w ill be p r e s e n t e d below. [67]

The f i r s t model represents the case of non-mutually

exclusive, independent projects competing in a time of capi­

tal rationing. The objective of the economic analysis is to

maximize:

P
E NPW. x . (4.21)

subject to:

P
(4.22)
o

whe r e :

Cq is the maxi mum amount to be spent on capital

investm ents in period t Q.


166

t tl
NPWj is the net present worth of the j project.

th
Cj is the positive cash outlay required on the j

project in period t Q.

P is the total number of projects.

If the projects can e i t h e r be accepted or discarded

then integer programming is required,

where:
x = 1 if the prospective project j is accepted.
j
= 0 if the prospective project j is rejected.

If the projects can be accepted in 'portions, then

linear programming is required,

where:

0 < x . <1
J

The second model represents the case of m utually

exclusive projects which exist in a period of capital

rationing. The s a me m o d e l as presented in Equations 4.21

and 4.22 may be employed. However, in this case an a d d i ­

tional constraint must be a d d e d . In the case of integer

programming:

E x . < 1
j eJ J
167

where :

J is a set of mutually exclusive projects.

If fractions of mutually exclusive projects can be

accepted then linear programming is employed, where the x j /s

are not integers.

The c h o i c e of building systems and c o m p o n e n t s is a com­

plicated problem of capital budgeting, since building sys­

tems and components can be interdependent, or m utually

exclusive, or independent, or non-mutually exclusive, or

combinations of the above. In these cases, mathematical

modeling may be e n o r m o u s l y helpful, by reducing the amount

of complicated calculations .

If a set of projects in which an interdependency

exists, such that a project C can not be accepted unless a

project D is accepted, then the proper mathematical models

presented above may be employed w ith the added constraints

that :

x < x
C D
and

x <1
D
168

4.5.5 Lo n g T e r m C a p i t a l Budgeting

The time disparity problem b rought out a highly signi­

ficant assumption implied by n e t present worth and rate of

return analysis methods. These methods assumed that all

funds received or released by a p r o p o s a l are reinvested in

projects at the o rg an izatio n 's cost of capital or discount

rate. Such an assumption coincides with the procedure of

annual capital budgeting. However, an organization may

decide to examine the capital budget for a period of several

years. In this case, the timing of the release of funds

becomes quite im portant. If these funds are reinvested in

projects which promise a rate of return superior to that of

the o rg an izatio n 's cost of capital, the decision process

needs to be a l t e r e d .

In order to evaluate the situation described above, net

present value analysis must incorporate the added value of

the timing of released funds. Th e net present worth of the

cash flow can then be described as: [68]

N
N-t
I F ( 1 + r )
t
t =0
NPW (4.23)
a N
( 1 + i )
whe r e :

NPW is the adjusted net present worth of a project

which incorporates a different reinvestm ent

discount rate.
169

N is the total number of years of the a nalysis.

r is a reinvestm ent rate of funds released in the


f th
t year.

Obviously, the problem of considering several capital

budgeting periods lends i t s e l f to integer programming. A

sim ilar m athematical model as presented in Equations 4.21

and 4.22 can be u s e d with the t wo revisions shown i n Equa­

tions 4.24 and 4.25.

a=N j = P
maximize E E NPW x. (4.24)
a=l j = l aJ J
subject to:

E Ec x < Ca (4.25)
a =1 j =l J J
where :

£h
c . is the outlay of the j project in period a.
aJ

A basic argument against long term capital budgeting

exists. An organization might be forced to switch its

economic decisions on t h e basis of a probable future project

with a higher estim ated rate of return. This raises t wo

important questions. Why w o u l d a project, which under other

circumstances would be optim al, be discarded today on t h e

basis of a probable future project, a n d why s h o u l d an organ­

ization turn down a project, which has proven to be both

liquid and profitable at the cost of capital and the risk


170

class in which the shareholders expected that they were

investing in?

4^.^ Conclusion

In order to validate any procedure which employs a

method of economic analysis, the method of economic analysis

must be validated. Toward this end, several methods of

economic analysis have been presented. In addition, con­


clusive arguments in favor of the net present value and

equivalent uniform annual value methods of analysis have

been discussed. The weighted average cost of capital

method, which can be employed to evaluate the proper

discount rate, and other relevant economic topics were also

presented and discussed.

O verall, this chapter has presented an overview of

economic evaluation and ranking methods and considerations.

These methods and considerations have laid the necessary

groundwork to perform an accurate and complete economic

analysis. These analyses may be e m p l o y e d during the initial

design work, and during the course of future value engineer­

ing studies .

«
171

CHAPTER 5

LI FE CYCLE COSTING WITHIN VALUE ENGINEERING

5_. 1_ Introduction

Up t o this point, Life Cycle Costing has been referred

to and examined fro m an e c o n o m i c analysis view point. How­

ever, a true Life C y c l e ' Cos t i n g investigation is concerned

with mo r e topics than those of economic analysis and capital

budgeting. Life Cycle Costing can best be described as a

complete system atic method of investigation, employed to

examine the total costs of ownership expressed in constant

and equivalent dollars. Therefore, a complete Life Cycle

Costing system not only involves the economic evaluation

process, but also involves the procedure for estim ating

future life cycle costs.

The V a l u e Engineering methodology employs Life Cycle

Costing in order to properly measure, evaluate, and compare

the potential future cash flows of original and proposed

design and construction method alternatives. Hence, the

importance and necessity of Life Cycle Costing to Value

Engineering will be discussed. In addition, an overview of


172

the present role of Life Cycle Costing as employed w ithin

the Value Engineering methodology w i l l be discussed.

5.1.1 Development of L i f e Cycle C osting


W ithin Value Engineering

The objective of Value Engineering w ithin the Construc­

tion Industry is to increase the value of a project to an

owner. As d i s c u s s e d in Chapter 2, this may be done by

employing one and/or a combination of t wo m e t h o d s . First,


by i n c r e a s i n g the worth of the project, and second, by

decreasing the costs of a project. As pointed out in

Chapter 4, even though the economic life of a project might

only be three years, the life cycle costs of the entire use­

ful life of the project should be considered in the

analysis. A lower life cycle cost alternative would result

in lower costs both for the owner over his initial ownership

period, and for any future owners. Th e lower costs for

future owners transfers into an i n c r e a s e in value to the

present owner, since he wo u l d receive a larger s um o f mo n e y

from a p r o s p e c t i v e purchaser. As a result of the causal

relationship between lower life cycle costs and increased

value, the Value Engineering methodology has incorporated

Life Cycle Costing, which is applicable in different phases

of the Value Engineering Job Plan, as a sub-system.

A complete Life Cycle Costing system is first required

by the Value Engineering methodology in the first phase of

the job plan which involves inform ation gathering. Th e


173

identification of project sub-components, which require the

most study, is performed. In order to aid in the determ i­

nation of those building systems and components which pos­

sess the highest potential for value improvement, Life Cycle

Costing is employed. The life cycle costs of each building

system or component should be e n u m e r a t e d . By e m p l o y i n g the

technique of life cycle cost modeling those areas of the

building design which harbor the highest life cycle costs

and the poorest value may be i d e n t i f i e d .

The a n a l y s i s phase also requires the implem entation of

a complete Life Cycle Costing system. It is during this

phase that proposed design and construction alternatives are

compared to original methods. Although a life cycle cost

evaluation is not considered the total basis of the c om­

parison a mong alternate proposals, it is considered to be

very instrum ental in achieving the best value for the owner.

The d e ma n d f o r a system which could be employed to

evaluate the total cost of ownership in equivalent dollars

necessitated the integration of Life Cycle Costing w ithin

Value Engineering. The development of formal Life Cycle

Costing techniques as an a p p l i c a t i o n w ithin Value Engineer­

ing came a b o u t shortly after the Value Engineering methodol­

ogy was introduced to the Construction Industry. This can

be attributed to the realization that construction projects

differ from most m anufacturing products in that the costs of

ownership, past the initial cost of construction, equal and


174

possibly surpass the initial costs of construction itself.

_5. 2^ Importance of Life Cycle Costs

The ratio of recurring ownership and operating costs to

total costs of ownership for certain sub-components of

building designs is considered to be very large as compared

to most industries. Th e u s e f u l life period of a product of

the Construction Industry, whe n compared to other indus­


tries, may be considered uniquely long. The importance of

life cycle costs can be a t t r i b u t e d to this unique charac­

teristic.

Table 5.1 illustrates the importance of recurring costs

for a typical l ow r i s e office building located in New Y o r k

City. The costs are estim ations expressed in equivalent

dollars. Initial construction costs account for only 48.6

percent of total ownership and operating costs, whereas

recurring costs, which are experienced after the initial

construction period, account for 50.4 percent of the total

costs of ownership. Although this illustration estim ates

the recurring costs rather conservatively, as compared to

s ome authors, it still typifies the importance of life cycle

costs. This illustration alone can be considered a con­

clusive and persuasive argument in favor of the recognition

of the importance that life cycle costs should be accredited

with, during design and construction planning.


175

4J

m
o m
o o oo
m
O CO s*2

CO -H ••
•H <D

O O 00
O vC
00
o CO
00 CM
00 00 00
•H O P*

CO- co-
c
o

<0
i-.
o
CO o o o
3 o o o o o
o o
00 m v©
m a> 00
m CM o
a CO CO
•H rn rn CO­ co­ co­
SI co- co­ co-
CO
u
0)
c
3
O
<4-t
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co
o
a 4J

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4J •H

XJ JJ
cfl •H
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176

5.2.1 Significance of Life Cycle Costs

As m e n t i o n e d in Chapter 4, the economic and useful life

over which an economic analysis should consider pertinent

future cash flows, is determined by a n o w n e r ' s schedule and

intentions. However , if an owner's schedule calls for a

continuing occupation and/or operation of a facility, cer­

tain characteristics of the present worth factors will

influence the resolution of an applicable period for

analys i s .

Figure 5.1 is a graphical display of the present worth

factor for a series of uniform annual cash flows which last

n periods, for several discount rates. Depending on the

applicable discount rate employed, a point in time is

reached after which continuing present value analysis may be

considered negligible. For example, at a discount rate of

20 percent, the difference in the present worth factor for a

20 year series as opposed t o a 75 y e a r series is .1300. If

this factor were applied to a uniform annual cash flow of

$100,000, there is a difference of $13,000 between consider­

ing a 20 y e a r series as opposed to a 75 y e a r series. This

example illustrates that the consideration of a cash flow

series of this order of magnitude past 20 y e a r s is futile.

Figure 5.2 is a graphical display of the present worth

factor for a l ump sum c a s h flow n periods into the future,

for several discount rates. Depending upon the applicable


177

12 0000

10 3000 ■
Anna i t

9 .0 0 0 0 0 ■
an

7 50000 -
13 >.
of
F a c to r

6.00000 '
Worth
Present

ooooo ■

.50000 ■

00000
0 5 10 13 SO S3 30 33 MO

Number of Years of A n n u ltq

Figure 5.1 Significance of an A n n u i t y


178

Amount

.8 7 5 • C u rv e A I “ 10 ’<
C u rv e B i* t5 \
C u rv e C i =20 \
C u rv e 0 i “ 25

.750 -
a Fu tu re

.6 2 5 -
for

500 ■
Factor

375 -
Worth

250 •
Present

. 125 ■

0 00 10.0 30 0 60 0

Number of Years

Figure 5.2 Significance of a Future Amount


179

discount rate employed, the timing, past an initial period,

of a future cash flow, may be considered superfluous infor­

mation. For example, at a discount rate of 20 p e r c e n t , the

difference between the present worth factor for receiving a

future cash flow in the 20^ period as opposed to the 5 0 t '1

period is .026. If the future cash f l o w was $100,000, then

the difference in present value terms is $2,600. In a d d i ­

tion, the receipt of an a f t e r - t a x cash flow of $100,000 in


t
the 50 period, woul d represent a mer e $10 in present value
analysis utilizing the s a me discount rate.

Figures 5.1 and 5.2 demonstrate that the significance

of the timing and s i z e of future cash flows decreases very

sharply after as p e c i f i e d point in time, which varies with

the discount rate. This implies that the characteristics of

present worth factors shall influence the determination of

the period over whi ch life cycle costs shall be considered

signif ican t.

5.2.2 Identification of Life Cycle Costs

A life cycle cost may be defined as any future after­

tax cash flow which is considered relevant to the Life Cycle

Costing analysis of an investment being investigated. These

costs may be classified as recurring and n o n - r e c u r r i n g cash

flows. Energy and maintenance costs are examples of recur­

ring cash flows. Examples of non-recurring cash flows are

l ump sum c o s t s , such as replacement costs or salvage values.


180

Figure 5.3 displays a chart w h i c h was presented by A.

J. Dell'Isola at the 1976 Society of American Value

Engineers International Conference, defining the relevant

life cycle costs of construction projects. [71] As discussed

in Chapter 4, the inclusion of financing costs (block C-2)

as a life cycle cost involves a serious conceptual error.

In order to properly evaluate or compare investment

proposals, the life cycle costs, s h o wn in Figure 5.3, need

to be e s t i m a t e d and economically evaluated. An in-depth

definition and discussion of each of these classifications

of life cycle costs will be presented in Chapters 7 and 8.

5^3_ Current Prominent Life Cycle Cos t i n g Procedures

The topic of development of a complete Life Cycle Cost­

ing system, specifically tailored for the Construction

Industry, has only recently evolved. Alphonse Dell'Isola

and Stephen J. Kirk initiated the research of such a system,

as applied within Value Engineering, in the early 1970's.

Since that time, many governmental agencies and other organ­

izations, which have realized the need for such a system,

have initiated research on t h e topic.

The p u r p o s e of the remainder of this chapter is to

briefly summarize the prominent past and ongoing research

concerning the development of a complete Life Cycle Costing

system, which may be applied by the Value Engineering


f
tu
UJ

1
<o
181

o
s
ae
a
s!
ac
h-
Ul
O
fs,

Figure 5.3 Dell'Isola's Li f e Cycl e Costs


182

methodology within the Design and Construction Industry.

5.3.1 Society of American Val ue Engineers

Although the Society of American Value Engineers has

not formally adopted any particular Life Cycle Costing

methods, its membership has noted the popularity of the sys­

tem d e v e l o p e d by D e l l ' I s o l a and Kirk. These t wo r e s e a r c h e r s

have been responsible for the establishment and development

of Life Cycle Costing procedures and guidelines in many

agencies at both state and federal levels.

Dell'Isola and Kirk are the sole researchers who have

examined the privy of developing a complete Life Cycle Cost­

ing system. Their research is extensive, and has gained

wi de acceptance by the Design and Construction Industry.

Although their economic a n a l y s i s techniques incorporate con­

ceptual errors, such as the inclusion of financing costs,

they have developed the framework for a complete Life Cycle

Costing system. In what has been termed as an 'Industry

First'; they have attempted to develop a life cycle cost

database to compliment their Life Cycle Costing procedures.

Basically, this system involves the estimation and

economic evaluation of the life cycle costs for building

components and subsystems, as identified in Figure 5.3. In

addition, their research has initiated the empl oyment of a

construction cost coding format as the basis to form a


183

complete Life Cycle Costing system. Both their Life Cycle

Costing s y s t e m and database e mpl oy Uniformat, a construction

cost coding format based on b u i l d i n g systems.

5.3.2 National Bureau of Standards

At the request of the Building Economics Subcommittee

of the American Society of Testing and M a t e r i a l s ( ASTM) , the

National Bureau of Standards has initiated a series of ongo­

ing investigations into the development of a comprehensive

set of standard economic practices, whi ch will meet the

diverse needs for the measurement of economic performance by

the building community. [72]

In a d d i t i o n to requests from t he American Society of

Testing and Materials, and the building community, this

ongoing research effort is an e x t e n s i o n of earlier research

initiated by the National Energy Conservation Policy Ac t of

1978 and an e a r l i e r executive order by President Carter,

whi ch mandated related research. These earlier investiga­

tions researched Life Cycle Costing techniques specifically

tailored to promote energy conservation in both the federal

and p r i v a t e building community.

The National Bureau of Standard's research does not

attempt to develop a complete Life Cycle Costing system.

Rather, it investigates alternate methods of economic

evaluation and comparison. It should be noted that the


184

research is ongoing, and presently falls short of the

finance principles presented in Chapter 4. The research

conflicts with common f i n a n c e principles on the following

topics: 1) the inclusion of financing costs 2) the met hod of

deriving the discount rate a n d 3) the research advocates the

utilization of the rate of return met hod of analysis as

opposed to the net present value method.

5.3.3 Other Organizations

The list of other past and ongoing research on this

topic is immense. Governmental agencies have developed

manuals for rules and guidelines of e c o n o m i c a n a l y s i s

methods which are tailored s p e c i f ic a ll y for t h e i r own use.

Among t h e s e agencies are the United States Air Force, Navy,

Ar my Corps of Engineers, the National Aeronautics and Space

Administration, the Department of Health Education and We l ­

fare, the General Services Administration Public Building

Service, and more. The reports and guidelines these agen­

cies issue degrade into a basic review of engineering

economics. However , three organizations' research on this

topic have yielded s ome interesting and p e n e t r a t i n g results.

The first organization, the American Institute of

Architects, issued a series of reports in 1977 and 1978

entitled 'Life Cycle Costing Analysis - A Gui de For Archi­

tects' and 'Life Cycle Costing Analysis - Using It In P r a c ­

tice' respectively. Although these reports suffer from the


185

s a me finance related deficiencies mentioned above, they do

discuss necessary topics of practical application and the

importance of incorporating a Life Cycle Costing system into

the design and construction phases of a project's develop­

ment. Such information is necessary and imperative in order

to develop a complete Life Cycle Costing s y s t e m which may be

applied readily in private industry.

The s e c o n d organization, the Construction Engineering

Research La b in Champaign, Illinois, is presently research­

ing methods concerning the collection and a s s e m b l a g e of life

cycle cost data. The research, which w i l l be discussed in

Chapter 7, has yielded s ome necessary insight into the

development of a life cycle cost database.

The third organization, the Building Own e r s and

Manager s Association International ( BOMA), annually collects

and a s s e m b l e s life cycle cost data from over 3,171 buildings

through out the United States and Ca na da . The data is col­

lected and formatted into an a n n u a l report entitled ' BOMA

Experience and Exchange Report'. Methodology utilized for

the collection and a s s e m b l a g e of this type of data has

yielded s ome important insights into the privies involved in

the collection and formatting of life cycle cost data for

the private building community.


CHAPTER 6

THE ESTIMATING LINK

Prior to the development of a complete Life Cycle Cost­

ing system three topics need to be e x p l o r e d and expanded on.

First, the requirement that the Life Cycle Costing system be

able to interact readily with existing estimating systems,

will necessitate the presentation of a brief overview of the

existing estimating process for initial construction costs

within the Construction Industry. Second, in order to

develop a systematized Life Cycle Cost system ands u p p o r t i v e

database, a met hod of organization and classification of

life cycle costs is indispensable. Thisrequirem ent will

necessitate the review of prominent cost coding systems

which are already established within the Construction Indus­

try. Lastly, the detailed requirements of a complete Life

Cycle Costing system w ill be defined.

J^.l_ Es t i m a t i n g Sy s tern I n t e r a c t i o n

A Life Cycle Costing system requires thee s ti m a t io n of

both the quantity andt i m i n g of the total costs of


187

ownership. The initial costs of construction represent a

substantial portion of these costs. Th e development of ini­

tial construction cost estimates has been the topic of a

great number of research efforts. A presentation of

specific details of existing initial construction cost

estimating systems is beyond the scope of this dissertation.

However , a brief discussion of the construction estimating

process and how it interacts with the Life Cycle Costing

system is presented.

Figure 6.1 depicts a time-line for the different phases

through out the life of a construction project. The center

time-line represents a typical construction project's

development from c o n c e p t i o n to disposition. The right most

time-line exhibits established estimating systems which can

be employed at various points through out a construction

project's development. The left-most time-line on the

diagram manifests the interaction of Value Engineering, and

thereby Life Cycle Cost estimating, within a project's

development.

As d i s c u s s e d previously, an optional preliminary value

engineering study may be p e r f o r m e d at the 20 p e r c e n t design

phase. This type of value engineering study requires a life

cycle cost estimating s y s t e m which can be linked to concep­

tual construction cost estimating systems. This capability

woul d ease acceptance and implementation a mo n g contractors

and design firms.


188

VALUE ENG1NEEING PROJECT CONSTRUCTION COST


SYSTEM DEVELOPMENT ESTIMATING SYSTEM

SCHEMATIC
DESIGN PARAMETRIC, FACTOR
I OR RANGE
PRELIMINARY ESTIMATING
VALUE ENGINEERING
STUDY

A/E APPROXIMATE
CONCEPTUAL
M FINAL CONSTRUCTION ESTIMATING
VALUE ENCINEERINC
STUDY VOHKING DRAWINGS

CONTRACT DOCUMENTS DETAILED


CONSTRUCTION
ESTIMATE
PROJECT
LETTING
PROGRESS PAYMENT
VALUE ENGINEERING
& CHANGE ORDER
INCENTIVE PROPOSALS
ESTIMATING

PROJECT
COMPLETION

VALUE ENGINEERING
OPERATION
OPERATION STUDIES
ESTIMATES

SALVAGE

Figure 6.1 Construction Project Timeline'


189

At the 60-80 percent design phase, prior to the comple­

tion of the working drawings and construction documents, a

final value engineering study may be performed. Since

recommendations resulting from t h i s type of value engineer­

ing study are specific in nature, the study requires the

utilization of mo r e detailed and refined life cycle cycle

estimates. This life cycle cost estimating system should

assimilate detailed initial construction cost estimating

systems which a contractor might e mpl oy in order to prepare


a bid for a project.

A possible option for a third application of Value

Engineering exists between the letting and completion of the

construction phase of a project. Value Engineering Incen­

tive Clauses may be utilized by c o n t r a c t o r s during this

phase. This application of Value Engineering will require

the s a me detailed life cycle cost estimating system as

required in the final value engineering study performed

toward the end of the design phase. This detailed life

cycle cost estimating system w ill be required in order to

properly evaluate the significance of alternatives proposed

by c o n t r a c t o r s .

A fourth and final application of Value Engineering may

be employed by p e r f o r m i n g a value engineering study on the

project during its operational phase. As energy and labor

costs increase, mo r e a n d mor e value engineering studies will

be requested in order to generate retrofit proposals for


190

existing projects. These value engineering studies require

a detailed life cycle cost estimating system as described in

the previous t wo p h a s e s .

Table 6.1 presents the expected range in accuracy and

man-hours required for existing initial construction cost

estimating systems. [ 73] Life cycle cost estimating sys­

t e ms w h i c h interacts with these estimating systems should

it it
Table 6.1 Expected Accuracy of E s t i m a t e s

Type of Rangein Approximate


Es t i m a t e Accuracy Manhours

Unit c o s t p e r s q u a r e f o o t e s t i m a t e 40% 1
Range e s t i m a t e 30% 2
Factor estimate 20% 5
Parameter estimate 15% 10
C ontractor-detailed estimate 7% 150

* Assuming a $ 2 , 0 0 0 , 0 0 0 P r o j e c t .
** I n f o r m a t i o n from ' C o n s t r u c t i o n Estimating'.

produce similar results in accuracy and man-hour require­

ments. A conceptual life cycle cost estimating system util­

ized during a preliminary value engineering study requires a

range in accuracy of ± 20- 40%. A detailed life cycle cost

estimating system u t i l i z e d in any of the three remaining

applications of Value Engineering require a range in accu­

racy of ± 5 - 1 5 %. Although information on the number of

man-hours required to perform life cycle cost estimates is


191

unobtainable at this time, one might expect that values

similar to those for the initial construction cost estimates

w o u l d be reasonable. This woul d be a r e a s o n a b l e assumption

if a life cycle cost database is readily available. In

fact, if quantity surveys were already performed for the

initial construction cost estimate, one might expect the

number of man-hours required to perform a life cycle cost

analysis to decrease.

6_.j2 Construction Cost Codi ng

A construction cost coding system provides a system for

the accumulation of project cost data and the classification

of this data under separate wo r k items. The system assigns

both numerical and and a l p h a - n u m e r i c a l characters to each of

these wo r k items. In a d d i t i o n , the wo r k items are assembled

into a hierarchy of costs which breaks down i n f o r m a t i o n from

general categories into very detailed descriptive

categories .

Construction cost coding formats help to structure and

standardize the location of data and information within the

Construction Industry. Th e following is a list, which is

not nearly exhaustive, of methods of utilizing construction

cost coding formats.


192

- Organize project manuals.

- Organize cost estimates.

- File construction and design data.

- Format field data collection.

- Organize cost mana ge me nt functions.

- Organize planning and s c h e d u l i n g functions.

- Organize project monitoring functions.

Construction cost coding is a me a n s of communication for all

the me mb e r s involved in the design and construction of a

project .

Bot h standard cost codes and project cost codes are

utilized by contractors. A standard cost code is a master

code which encompasses an o r g a n i z a t i o n ' s entire wor k effort.

This cost code is employed to help summarize and organize

all information and data brought in and organized through

individual project cost codes. A project cost code is an

abbreviated and tailored version of a standard cost code

whi ch is specialized for an individual construction project.

Figure 6.2 displays an exampl e of the derivation of a pro­

ject cost code from a s t a n d a r d cost code. [74]

Two p r o m i n e n t standard cost codes exist today within

the Building Construction Industry; these are the M aster-

format and the Uniformat. The remainder of this section


193

M .uM .ii il
• iisl i Illll

I K c t. i » j i m /c \ c.iioi’o n / k -
j IK ’IcU * tm n c v .i'N v irv ilo n ix j
| p l i \ s ii..il & i!^opr.tphik..il
| M t u lit v u r c \ | k i i k I in ii* n ii. iiU p .ir ls >
i k . i i u r c s mi j u u i c i 1

Z Z
Z ---- 1
ZZ
Z
W W W w xxxxx \ i

h o t cc t A iv j-h k ilily W o rk - T y p e D klnfniliun


V m ih c r ( oilc ( mk’ ( 'ink*

U - T o ta l
I 3 L .ih n r
J = M j i i ’r u l
- l i11111M
11ci11
4 = S u l k o n i r j u ii i

Figure 6.2 D e v e l o p i n g a P r o j e c t Co d e F r o m a S t a n d a r d Code


* R e p r i n t e d from ' P r o f e s s i o n a l C o n s t r u c t i o n M anage ment ' .

will be devoted to a b r i e f presentation and description of

each of these t wo formats.

6.2.1 The M a s t e r f o r m a t

The M a s t e r f o r m a t is a trade data structured construc­

tion cost coding format. It has been prepared jointly by

the Construction Specifications Institute (CSI) and the Co n ­

struction Specifications Canada (CSC). It wa s first pub­

lished in 1978 as a revision of the Uniform Construction

Index (UCI), w h i c h wa s published in 1972 as a combination of

t wo e a r l i e r formats dating back to 1963 developed by the

United States a nd Canada. A revised edition of the M aster­

format was recently issued in 1983.


194

The organization of the Masterformat assimilates the

four major groupings of a construction project manual, as

f ollows :

- Bidding Requirements (Division 00)

- Contract F o r ms (Division 00)

- Conditions of the Contract (Division 00)

- Specifications (Division 1-16)

A list of the seventeen divisions are presented in Figure

6.3. The M a s t e r f o r m a t Utilizes a five digit numerical iden­

tification system for all titles within divisions. Divi­

sions are subdivided into three levels: broadscope, me di um-

scope, and n a r r o w s c o p e . Th e broadscope section titles are

shown- in capital letters with full five digit numbers. The

six broadscope section titles for the fourth division are

s h o wn i n Figure 6.4.

The m e d i u m s c o p e section titles are hyphenated three

digit numbers and the narrowscope section titles are unnum­

bered, indented titles. An e x a m p l e of the mediumscope and

narrowscope titles for division 4 is s h o wn in Figure 6.5.

Figure 6.6 describes the relation of scopes mo r e clearly.

The number at 0 serves as an overlap value, sometimes serv­

ing as a broadscope classifier and other times as a medi um­

scope classifier. [ 75]


195

Divis ion

00 B iddi ng R e q u i r e m e n t s , C o n t r a c t forms
a n d C o n d i t i o n s o f t h e Co n t r a c t
01 General Conditions
02 Sitework
03 Concrete
04 Masonr y
05 Metals
06 Wood a n d P l a s t i c s
07 Ther mal and M o i s t u r e P r o t e c t i o n
08 D o o r s a n d Wi n d o ws
09 Finishes
10 Specialties
11 Equipment
12 Furnishings
13 Special Construction
14 Conveying Systems
15 Me c h a n i c a 1
16 Elect ri cal

Figure 6.3 Masterformat List of Divisions

04100 M o r t a r

04150 MASONRY ACCESSORIES

04200 UNIT MASONRY

04400 STONE

04500 MASONRY RESTORATION AND CLEANING

04550 refractories

04600 CORROSION RESISTANT MASONRY

Figure 6.4 Masterformat Broadscope Level Exampl e


196

| D I V I S I O N 4 - M A S O N R Y 1
Section Tide j
Numbe r
1
| 04100 MORTAR |
Ce me n t a nd Li me M o r t a r s |
Chemical R e s i s t i n g Mort ars |
Epoxy M o r t a r s 1
High-Bond M o r t a r I
Ma s o n r y G r o u t s I
Mortar Coloring M a terials I
Preraixed M o r t a r s 1
| 04150 MASONRY ACCESSORI ES I
An c h o r s and T i e Sys t e ms ■ I
Control Joints 1
Jo in t Reinforcement i
| 04200 UNIT MASONRY I
| -210 Br i c k Masonr y I
| -220 C o n c r e t e Ma s o n r y 1
Expos e d A g g r e g a t e C o n c r e t e Un i t Ma s o n r y |
F l u t e d C o n c r e t e U n i t Ma s o n r y |
I n t e r l o c k i n g C o n c r e t e Un i t Ma s onr y |
Mo l d e d F a c e U n i t Ma s o n r y |
M o r t a r l e s s U n i t Ma s o n r y I
P r e f a c e d U n i t Ma s o n r y 1
P r e i n s u l a t e d U n i t Ma s o n r y |
S o u n d - A b s o r b i n g U n i t Ma s o n r y 1
S p l i t - f a c e U n i t Ma s o n r y |
| -230 R e i n f o r c e d U n i t Masonr y I
R e i n f o r c e d Gr o u t e d Br i c k Masonr y |
R e i n f o r c e d G r o u t e d ( i o n c r e t e Un i t Ma s o nr y l
| -235- P r e a s s e t n b l e d Ma s o n r y P a n e l s |
| -240 C l a y T i l e U n i t Ma s o n r y I
| -245 S tru c tu re d Facing Tile I
Sound-Absorbing S t r u c t u r a l Facing T il e |
|- -250 Cerami c Veneer !
T e r r a C ot ta Veneer 1
| -255 Ma s o n r y V e n e e r !
Adhered 1
Mechanically Supported |
I -270 G l a s s U n i t Ma s onr y 1
| -280 Gyps um U n i t Ma s o n r y 1
| -290 Adobe Ma s o n r y 1
| 04400 STONE |
-410 Rough S t o n e 1
| -420 Cut S t o n e |
-430 S im ul at ed Stone |
| -435 Cast Stone I
-440 Flagstone I
| -450 Stone Veneer |
-455 Mar bl e |
-460 Limestone 1
-465 Gr a n i t e 1
-470 Sandstone |
-475 Slate
04500 MASONRY RESTORATION AND CLEANING
I -510 Ma s o n r y C l e a n i n g 1
| -520 Ma s o n r y R e s t o r a t i o n 1
I 04550 REFRACTORIES 1
| -555 Flue L i n e r s I
-560 C o m b u s t i o n Ch a mb e r s I
| -565 Firebrick I
-570 Cascable R e f r a c to r i e s 1
04600 CORROSION RESISTANT MASONRY
-605 Chemical R e s i s t a n t Brick
-610 V i t r i f i e d Cl ay L i n e r P l a t e s ,

Figure 6.5 Exampl e of Masterformat Breakdown


197

Me d i u ms c o p e
Class i f i e r
t

Z Z X 0 Y

f
Division
I
Broadscope
Classifier Classifier

Figure 6.6 Masterformat Me t hod of Classification

The w i d e acceptance of the M asterf ormat can be attri­

buted to three characteristics. The M a s t e r f o r m a t is used by

specification writers to aid in the organization of project

manuals. Mo s t specification writers utilize this format or

a c o mp a n y modified version of this format. The M a s t e r f o r m a t

is organized along a trade orientation. Its organization

wa s intended to assimilate the met hod a contractor might

sublet individual portions of the wo r k for a construction

project. In a d d i t i o n , the Masterformat wa s the earliest

standard cost coding format introduced into the Construction

Indus t ry .

6.2.2 The U n i f o r m a t

The U n i f o r m a t is a design data structured construction

cost coding format. In 1973, the Public Building Service


198

division of the General Services A dm in i s t r a t i o n initiated

the development of a systems oriented format entitled the

Uniformat. At the s a me time, Ha n s c o mb A s s o c i a t e d Inc. con­

ducted a feasibility study for the American Institute of

Architects on t h e development of a building components for­

mat entitled Mastercost. Both of these efforts resulted

from the realization that the Uniform Construction Index,

the already established cost coding system w ith in the Co n ­

struction Industry, was w e l l suited for the construction

documents and construction phase but was not the optimal

format for the design phases of project development. During

the early conceptual design phase of a construction project,

a new s y s t e m s oriented format is required which would pro­

mo t e the examination of the cost effectiveness of alternate

building systems and c o m p o n e n t s . In' 1974, H a n s c o mb Associ­

ates coordinated their efforts with those of the General

Services Administration and developed a building systems

oriented format entitled Uniformat.

Th e U n i f o r m a t provides for project identifier informa­

tion by including 147 b u i l d i n g descriptors. The building

descriptors provide for the storage of statistical and

descriptive data in five categories as follows:

A. General data

B. Procurement
199

C. Statistics

D. Ratios

E. Performance Characteristics, specifications,

and capabilities.

A L i s t of the 147 building descriptors are provided in

A p p e n d i x B.

Table 6.2 displays levels one and t wo o f the Uniformat.

Section A of level 1 has been developed in detail presently.

Sections B, C, and D provide room f o r expansion and further

development. Section A of level 1 is subdivided into 12

sections, whi ch make up the second level. These 12 s e c t i o n s

are further broken d o wn . Fig 6.7 displays an example of the

third and fourth level breakdowns for section Q1 of the

second level.

Appendix C displays an e x a m p l e of levels 4 through 10

breakdown for section 0111, Wa l l Foundations. The nomencla­

ture used for the breakdowns is explained further in Figure

6 .8.

Inherent in the standard code is a future expansion

into life cycle cost information such as: cost of opera­

tions, maintenance, repair, alteration, and disposition of

the structure. This collection of life cycle cost data

woul d lend itself to system comparison in a mo r e complete

and equitable fashion than present techniques of initial


200

Table 6.2 Uniformat Levels 1 & 2

Level 1 Level 2 |
A. CONSTRUCTfON 01 Foundations |
02 Substructure ,
03 Superstructure
04 E x t e r i o r Closure
05 Roofing |
06 Interior Construction
07 Co n v e y i n g Systems
08 Me c ha n i c a l
09 Electrical
10 G e n e r a l C o n d i t i o n s and P r o f i t
11 Equipment
12 Sitework
B. design and REVIEW ^ 01 Personnel Services |
02 A r c h i t e c t - E n g i n e e r f e e s and 1
services |
03 C o n s t r u c t i o n Ma na ger I
04 Consultants I
05 S o i l and Ot her P r e - C o n s t r u c t i o n |
Testing |
06 I n v i t a t i o n and R e p r o d u c t i o n C o s t s |
07 Travel Costs I
08 Da t a P r o c e s s i n g |
09 Other |
C. MANAGEMENT a n d INSPECTI ON 01 Personnel Services
02 A r c h i t e c t - E n g i n e e r Fees and
Services
03 C o n s t r u c t i o n Ma n a g e m e n t
04 Consultants
05 Consultants
06 Materials Testing
07 Travel Costs ,
08 Dat a P r o c e s s i n g
09 Other |
D. SI TE ~l of Personnel Services |
02 La n d Cos t I
A p p r a i s a l a nd L e g a l Fees |
03
04 Su r v e y s |
201

01 F O U N D A T I O N S

Oil STANDARD FOUNDATIONS

0111 WALL FOUNDATIONS

0112 COLUMN FOUNDATIONS & PI LE CAPS

SPECI AL FOUNDATION CONDITIONS

0121 PI LE FOUNDATIONS
0122 CAISSONS

0123 UNDERPINNING

0124 DEWATERING

0125 RAFT FOUNDATIONS

0126 OTHER SPECI AL FOUNDATION CONDITI ONS

Figure 6.7 Exa mpl e of Uniformat Levels 2, 3, & 4 Breakdown

construction cost comparison. [76]

6.2.3 Industry Acceptance and Developments

As previously discussed in Chapter 3, 90 a n d 60 percent

of the contractors and d e s i g n firms respectively within the

Construction Industry utilize construction cost coding for­

mats. In addition, the survey revealed that 25-45 percent

of the industry empl oys the Masterformat, while 0, 6.8, and

23.8 percent of the contractors, design firms, and Value


202

The d a t a b a s e i s l a i d o u t by i n d e n t i n g s u c c e s s i v e l e v e l s .
L e v e l s 2, 3 a n d 4 a r e i d e n t i f i e d by t w o , t h r e e a n d f o u r
d i g i t c o d e s , and i n t h i s d i s p l a y t h e h i g h e s t l e v e l b e g i n s
with a level 4 d e s c rip to r. B e l o w t h i s , l e v e l s c a n be
i d e n t i f i e d as f o l l o w s :

(1) level 5

(a) level 6

01 level 7

A- level 8

- level 9

level 10 no dash/no prefix/no symbol

As c a n be s e e n , no codes are a p p l i e d to l e v e l 9 and beyond,


as the u t i l i t y of additional digits be c ome s q u e s t i o n a b l e a t
this level.

Figure 6.8 Uniformat Nomenclature

Engineering firms respectively employs the Uniformat. A

major portion in each case stated that they e mpl oy c ompa ny

developed cost coding formats and the majority of these

stated that their c o mp a n y developed format was a tailored

version of the Masterformat.

The low acceptance which Uniformat has experienced

within private industry can be a c c r e d i t e d to its late intro­

duction to the Design and Construction Industry. The

Uniformat wa s first developed by the General Services


203

Administration in 1975, approximately 12 years after the

Construction Specifications Institute first introduced their

earlier formats to the industry. On l y eight years have past

since the Uniformat was first developed and introduced into

government construction and the industry still k n o ws very

little about its existence. In addition, organizations

whi ch ha ve data files and estimating systems organized along

the guidelines of the H a s t e r f o r m a t , shy aw ay from the ardu­

ous task of restructuring their organization's coding sys­


tem. However firms such as Smith, Hinchman, and Grylls

Associates, Inc., of Detroit, Michigan has developed a c o m­

puterized system to expedite the exchange of information and

data between the Uniformat and the M a s t e r f o r m a t . Wi t h the

advent of systems such as the one Smith, Hi nchman, and

Grylls have developed mo r e organizations will find the util­

ization of the Uniformat a virtually costless luxury.

Other industry developments, in the area of cost cod­

ing, include the development of a wi de range of estimating

manuals and consultants such as: R. S. Me a n s C o mp a n y , Orr

System of Construction Cos t Management , Richardson Engineer­

ing Service, Berger Building Cost File, Eaglesman Construc­

tion Costs, and more. These cost data banks are organized

along cost coding formats whi ch are tailored and a me nde d

versions of either the Masterformat or the Uniformat. This

has aided the uniformity of the Construction Industries data

and information files and o v e r a l l communication.


204

6.2.4 Hierarchy of Cost Co d e s

Bot h the Masterformat and U n i f o r m a t are hierarchically

organized. This arrangement of levels and sub-levels allows

a wi de variance in the levels of detail which can be

achieved in the estimating process. In a d d itio n the hierar­

chy allows for different levels of reporting. For example,

upper management w o u l d be mo r e responsive to receiving s u m­

mation reports on prime level accounts than they woul d

receiving several hundred pages of sub-level information.

Wher eas a superintendent woul d be m o r e apt for using sub-

level information for his particular division than receiving

conglomerate project information.

Another level of hierarchy which aids in the develop­

me n t of mo r e detailed information is the breakdown of stan­

dard cost code line items into a distribution code such as

s h o wn in Figure 6.2. This breakdown can be u s e d to store

information such as labor hours as opposed to labor dollars.

A data file storing labor hours is less likely to be

affected by economic factors, such as inflation, than a data

file storing labor dollars.

The h i e r a r c h y of information provided in Masterformat

and Uniformat enhances the capabilities of an exchange of

information a mong them. The optimal level to exchange

information between these t wo cost coding formats is at the

material levels. At this level the Uniformat's building


205

system information is sub-divided into section titles clas­

sified by materials, and the Masterformat's procurement

division information is also classified according to materi­

als. It is at this level whi ch the best opportunities exist

for the matching and e x c h a n g i n g of information between the

t wo cost coding formats.

Another feature of the hierarchy of cost codes is the

ability to conglomerate information. The conglomeration of

information at upper division levels can be e m p l o y e d to aid

in conceptual estimating systems. For example, if all the

construction costs for a material are s ummed and then all

these material costs for an exterior wall system are s u mme d ,

a price for an exterior wall system is arrived at.

6^3_ R e q u i r eme n t s of a_ L i f e Cycle Cos t i n g System

In order to mor e clearly define the requirements of a

Life Cycle Costing system, the term system, and in particu­

lar Life Cycle Costing system, requires classification.

The o b j e c t i v e of a system, is to routinely utilize all

available information to arrive at an o p t i m a l decision. A

system is a met hod or plan to organize and coordinate all

available information and e l e m e n t s and to feed this informa­

tion through a set of routine procedures of analysis. It is

the met hod of s u mmi n g a n d correlating diverse elements in

order to derive a coherent and accurate conclusion. [77]


206

A Life Cycle Costing system can be described as a

met hod of collecting and coordinating life cycle cost data

and p r o c e s s i n g this data through a set of routine procedures

of life cycle cost analysis with the objective of arriving

at an optimal decision. It is a step-by-step plan for gath­

ering and processing life cycle cost information during the

design and construction decision making-process.

Three major components of system description and

development exist; they are as follows:

- Performance Requirements

- Performance Criteria

- Performance Test

Performance requirements are a series of qualitative state­

me n t s describing the desired performance of the system.

Performance criteria are a series of quantitative and

detailed statements describing the process of the system. A

performance test is an e v a l u a t i o n of the system to assure

compliance with the criteria. [78]

The performance requirements for a Life Cycle Cost sys­

tem will be defined in the remainder of this chapter. The

performance criteria for the system will be described in

Chapters 7 and 8. The researcher will be unable to perform

a test of the system. The failure for performing a test of

the system can be attributed to the complexity of the


207

system. Part of the system will describe the development of

a supportive life cycle cost database. This development

woul d require the collection of data for many y e a r s which is

not a feasible task for this research effort.

The p e r f o r m a n c e requirements of the proposed Life Cycle

Costing system are separated into requirements for the

actual s y s t e m and for the development of the supportive

database. Th e performance requirements for the life cycle


cost database development will be presented at the end of

Chapter 7; the performance requirements for the Life Cycle

Costing system presented in the next chapter are as follows:

1. Th e L i f e Cycle Costing system shall be a b l e to provide

optimal life cycle cost information for the conceptual

and b u d g e t i n g design phases of a building construction

project.

2. The Life Cycle Costing system shall be a b l e to provide

optimal life cycle cost information for the construc­

tion phase of a building construction project. This

phase requires detailed estimates of life cycle costs.

3. The L i f e Cycle Costing system shall be a b l e to provide

optimal life cycle cost information for the operation

phase of a building construction project. The first

t wo requirements examine alternate design proposals

before purchasing and installation. This requirement

examines the replacement of already procured and


208

installed items. As w i l l be s h o wn i n the next chapter,

these t wo a r e dramatically different.

Th e s y s t e m s h a l l be practical and a p p l i c a b l e for u tili­

zation within the Construction Industry. Although for­

ma l interviews will not be presented, the research will

be discussed with several representatives of industry.

The s y s t e m s h a l l be compatable with existing initial

construction cost estimating systems.

The s y s t e m shall attempt to achieve the derivation of

the best possible design and construction methods solu-

t ions .

Th e s y s t e m s h a l l be sympathetic to an owner's future

plans and schedules.

The system shall incorporate all pertinent available

information, including predictions for future economic

c l i m a t es .
209

CHAPTER 7

PROPOSED LI FE CYCLE COST SYSTEM

In this chapter, the performance criteria for the pro­

posed Life Cycle Cost system shall be p r e s e n t e d with an

emphasis on b u i l d i n g construction applications. It is pro­

posed that with minor modifications, the system could be

applied to other types of construction. The performance

criteria provides a set of general guidelines and objec­

tives. This system is not completely definitive in all

aspects. Its lack of rigid definition allows the flexibil­

ity to adapt to the special circumstances of each environ­

me n t within which it is utilized.

7_. 1_ Sys tern D e s c r i p t i o n

Figure 7.1 defines the logic of individual steps in the

proposed Life Cycle Cost system. This system u t i l i z e s

several sources of input and yields a single output; the

first source of input being identification of the owner's

criteria for the project and the owner's operating profile.


210

INPUT tt l

IDENTIFY
OWNER'S CRITERIA
& PROFILE

ESTABLISH
PROJECT PARAMETERS

DEFINE DESIGN
INPUT # 3
CONSTRAINTS DEFINE ALTERNATE

CONSTRUCTION

DESIGNS Si METHODS

PREPARE LIFE
PREPARE INITIAL
INPUT #
CYCLE COST
CONSTRUCTION
ESTIMATE
COST ESTIMATE

PERFORM LIFE
CYCLE COST
ECONOMIC
ANALYSIS

EMPLOY LIFE
CYCLE COST
MODEL

SENSITIVITY ANALYSIS

SELECTION TECHNIQUES

OPTIMAL
CONSTRUCTION
DESIGN
OR
METHOD

Figure 7.1 Proposed Life Cycle Cost System


211

This is an i m p o r t a n t step within the system. Without proper

identification of an owner's needs, the system could yield a

sub-optimal decision. A checklist, such as the one s hown i n

Figure 7.2, may be employed to aid the gathering of neces­

sary information from the owner.

OWNER' S CRI TERI A & PROFI LE CHECKLI ST

#1. R e q u i r e d Q u a l i t y of C o n s t r u c t i o n .
if2 . R e q u i r e d Q u a n t i t y of C o n s t r u c t i o n .
if3 . D e s c r i p t i o n of R e q u i r e d S p e c i a l E q u i p m e n t .
if 4 . D e s c r i p t i o n of S p e c i a l R e q u i r e m e n t s .
if5 . Future Plans & Schedules f or the P r o j e c t .
if 6 . Q u a l i t a t i v e D e s c r i p t i o n of O p e r a t i o n s .
#7. Q u a n t i t a t i v e D e s c r i p t i o n of O p e r a t i o n s .
if 8 . T otal I n i t i a l C a p ita l A vailable for the P r o j e c t .
if9 . Owner's A f t er - T a x Discount Rate.
7/ 10. O w n e r ' s Ta x B r a c k e t .

Figure 7.2 Example of Owner's Criteria & Profile Checklist

Items if 1 t h r o u g h 5 provide input from the owne r which aids

in defining project parameters. Items if5 t h r o u g h 7 define

the operating profile for the system. Items if5 a n d 8 estab­

lish initial constraints on construction methods and

designs. Items if9 a n d 10 p r o v i d e the information necessary

to perform an accurate life cycle cost analysis. A rule,

whi ch applies to all data extracted from the owne r for items

if 1 through 10, is that all owner's wants require conversion

to owner's needs. If initial parameters and constraints are

too stringent, they may eliminate the generation of


212

alternatives, whi ch eventually eliminates the need for this

Life Cycle Cost system.

The s e c o n d and third inputs are in the form of cost

data. Th e y require that the user have access to an initial

construction cost and life cycle cost database, respec­

tively. Many databases, which satisfy the requirement of

the second input, exist. However, the number of databases

available for the third input are limited. This fact will

be discussed in mo r e detail in Section 7.4.

Onc e the owner's criteria and profile have been identi­

fied, and the constraints and parameters defined, all alter­

nate designs and met hods of construction being considered

need to be defined in detail. Although the generation of

proposals is not within the realm of this system, they do

need to be defined and clarified in order to promote an

accurate evaluation of the decision. Through the careful

consideration of design constraints and project parameters,

several of the construction designs and methods may be elim­

inated at this point. However, none of the proposals should

be e l i m i n a t e d at this point for economic reasons. The

definition of designs may create new d e s i g n constraints,

such as the development of mutually exclusive relationships

or interrelationships. For example, a 10' floor- to-floor

height may n o t be a f e a s i b l e proposal unless a l ow volume,

high velocity, ductwork system design is accepted.


213

The next phase of steps requires the development of

both initial construction cost and life cycle cost esti­

mates. As discussed previously, many initial construction

cost databases exist. Life cycle cost databases require

further development, however, with the use of these data­

bases and other estimating techniques, alternate construc­

tion designs and met hods c a n be e v a l u a t e d in terms of cost.

Depending on the phase of a project's development during

which the proposed Life Cycle Cost system is employed, a

conceptual or detailed life cycle estimate is required.

Onc e t h e development of estimates for the alternate

proposals iscompleted, a life cycle cost analysis may be

performed. All costs should be expressed in terms of

after-tax effects for the owner. The a n a l y s i s requires

input from the o wn e r with respect to cost of capital, cor­

porate tax brackets, and more. The Ne t Present Val ue method

of analysis is r ecommended. The net present value of each

alternative's after-tax cash flows must be computed, employ­

ing all the guidelines and principles presented in Chapter

4. Onc e the net present value is comput ed for each alterna­

tive, results, along with the designer's and owner's con­

straints, are fed i n t o the life cycle cost mo d e l s h o wn in

Equation 7.1.

12 Pi
Minimize Z I NPV. . x. . (7.1)
i=l j-1 ^ ^
214

whe r e :

t tl
NPV . . is the net present value of costs for the j
t tl
alternative for the i division of the Uniformat.

is the total number of alternate proposals for the

combination of sub-systems in the i C^ s y s t e m in

the project .

i is the Uniformat division number of the building

system.

x^j=0 if the construction design or method is rejected.

x ^ =l if the construction design or met hod is accepted.

Since most construction related decisions do n o t allow

the acceptance of portions of alternatives, integer program­

ming, as opposed to linear programming, should be employed.

However , linear programming, along with other economic cli­

mates, c a n be properly modeled, as presented in Chapter 4.

The constraint equations for the model are derived from b o t h

the designs and the owner's profile. An owner's profile

constraint, for example, might be the a mount of initial cap­

ital available. Mo s t design constraints will be derived

from the mutually exclusive or interdependent relationships

whi ch might exist a mong the proposed designs and/or con­

struction methods.
215

The n e x t phase of steps in the system are considered

optional. The topic of sensitivity analysis will be dis­

cussed in depth in Chapter 9. Selection techniques, such as

the criteria weighting technique presented in Chapter 2, may

be e m p l o y e d . This selection technique allows for the inclu­

sion of non-quantitative factors in the decision maki ng pro­

cess. Following this step, assuming all available accurate

information has been input and processed properly, an

optimal solution may be derived.

7.1.1 Hi gh Cos t Building Systems

In order to derive the ma xi mum beneficial utilization

of the Life Cycle Costing system, the building components

whi ch h a r b o r the largest portions of the total life cycle

costs, must be identified. Two sources of data will be

examined in order to d r a w some conclusions about the rank,

in order of operating and maintenance costs, of the 12

building systems, as defined by the Uniformat.

Research by the Construction Engineering Research

Laboratory, at Chamapaign, Illinois, has examined data col­

lected for t wo y e a r s from t wo forts, combi ned w i t h district

questionnaire results. Th e resulting ranking of building

components, from h i g h to l ow, with respect to maintenance

and repair costs, are as follows: [79]

- Heating System
216

- Cooling System

- Flooring System

- Electrical System

- Structural System

- Roofing System

This ranking includes simple repair and maintenance costs

and ignores operating (energy), and initial costs.

The second source of information is the BOMA E x p e r i e n c e

and Exchange Report. This report collects operating and

maintenance data for office buildings throughout the United

States and Ca nada. Although this source does not categorize

life cycle costs according to building systems, it's clas­

sification of costs according to type of expense does pro­

vide helpful input toward the ranking of building systems

whi ch harbor high life cycle costs. The a v e r a g e costs for

office buildings are ranked, from h i g h to l ow, as follows:

[80]

- Utilities

*
- Fixed Expenses

- Repairs/Maintenance

- Cleaning
- Administrative

* Fixed expenses account for taxes and i n s u r a n c e .

Although these t wo sources alone do n o t provide enough

information to accurately conclude a ranking a mo n g b u i l d i n g

systems, the classifications do i d e n t i f y high cost areas.

Figure 7.3 proposes which systems may be a t t r i b u t e d with

high costs for four different life cycle costs. Hopefully,

once life cycle cost databases are developed, the cost

information needed w i l l be m o r e readily attainable.

7.1.2 System F l e x i b i l i t y

Built in flexibility within the proposed Life Cycle

Costing system is required in order to assure wi de accep­

tance by the Construction Industry. The p r o p o s e d Life Cycle

system offers a degree of flexibility in s e v e r a l aspects.

First, the system can be utilized for construction pro­

jects in the conceptual design phase, the construction

phase, or the operational phase. The only stage of the sys­

tem which requires alteration, in order to conform to these

different phases of a project's development, is the develop­

me n t of life cycle cost e s t i m a t e s . The d e v e l o p m e n t of these

estimates for different phases w i l l be discussed further in

Section 7.2.

Second, the system offers flexibility in the area of

criteria and constraint development. Constraint equations


Recurring Coses
1

Hi g h Hi g h Hi g h R e p a i r & Hi g h |

| Uniformat Initial Energy Maintenance Custodial|

Cos t Cos t Cos t Cost |

| Foundations X

| Substructure X

S u p e r s t r u c t u re X

Exterior Closure X X

Ro o f i ng X X

Interior Construction X

Conveying System X

Me c ha ni c a l X X X

Ele ct r i cal X X X

General Conditions

Overhead, & Profit X 1


1

Eq u i pme nt
x x 1
.1 1
S i t e wo r k 1 1 X i

1 ! J

Figure 7.3 Building System Costs


219

for the life cycle cost model may be developed to model the

specific decision making and economic environment of the

construction project for the owner. In a d d i t i o n , constraint

equations may be developed to model special design con-

s ide r a t ions .

A third and fourth dimension of flexibility, inherent

in the proposed system, are the allowance for steps which

involve sensitivity analysis and selection techniques. A

sensitivity analysis involves determining the effects on the

final decision, of employing different values for different

variables within the model. Other selection techniques

incorporate latitude in the inclusion of non-quantitative

criteria within the decision maki ng process. Mo s t economic

and other quantitative criteria may be incorporated in the

system through the life cycle cost estimates, analysis, and

model.

7.1.3 Implementation Techniques

The a mo u n t of flexibility built into the system denies

the use of excessively strict rules and guidelines for

implementation. Principles of economic analysis must be

empl oyed consistently. Economic items to be considered are:

all applicable after-tax cash flows, inflation and differen­

tial escalation rates, elimination of sunk costs, and u t i l i ­

zation of appropriate discount rates, a mong others.


220

All possible combinations of alternatives must be con­

sidered in the final evaluation. An e x a m p l e illustrating

this guideline is displayed in Figure 7.4. The simplicity

of the alternatives and number s utilized are for illustra­

tive purposes only. Suppose a cooling s y s t e m was in need of

repair and three alternatives were proposed for the project.

Capital restrictions a l l o w o n l y $300 for the project.

Either a chilled water s y s t e m or a refrigerant s y s t e m may b e

employed; however, one of the t wo must be employed. In

addition, an optional energy saving control system could be

utilized. All net present values are expressed in terms of

cost, and include initial required capital outlay. As s h o wn

in Case I, a sub-level decision between t.h e t wo cooling sys­

t ems woul d result in the acceptance of the refrigerant sys­

tem. Th e initial capital restriction for the project causes

the acceptance of this alternative to necessitate the rejec­

tion of the control system a l t e r n a t i v e . Therefore, the sub-

level decision process results in the acceptance of a n

alternative with an initial capital outlay of $300, and a

net present value of $390.

The proposed life cycle cost model automatically con­

siders all alternatives subject to the constraints defined.

Th e first constraint equation necessitates the choice of

either the chilled water or refrigerant system, but not

both. Th e second constraint equation defines the restric­

tion on the initial capital available. As s h o wn i n Case II,


221

CASE I» Simple Decision Analysis

Design A: C h ille d V ater HPV=$420

I n i t i a l Cost = $ 100
Design B= R e frig e ra n t

I n i t i a l Cost = $300
Design Bi R e frig e ra n t HPV=$390 HPV - $390
I n i t a l Cost = $300 Solutlon< Design B
I n i t i a l Cost = $300

Design Ci O ptional HPV = $390


C o ntro l System
I n i t i a l Cost = $200
HPV = -200

CASK I I : L if e Cycle Cost Model

C
Minimise.- Sum HPV(J) XCJ) X (J ) = 0 or 1
j=A

Sum 420 XCA) + 390 X(B) -20 0 X(C)

Subject To: 1 ) XCA) + X(B) = 1

2 ) 100 XCA) + 300 XCB) + 200 X(C) = 300

SOLUTION: Designs A & C

Optimum O bjective Function = $220

XCA) = 1
XCB) = 0
XCC) = 1

A reduced cost o f $170 over Case I

Figure 7.4 Exa mpl e o f the Life Cycle Cost Mo d e l


222

empl oyment of the model results in the acceptance of the

chilled water system and the control system. For this deci­

sion, the initial capital outlay requirement is $300; how­

ever, the net present value of the t wo s y s t e m s together is

only $220, as opposed to the $390 derived from the logic of

Case 1.

Although this is a very simplistic case, it does d e mo n ­

strate that sub-level decision maki ng may r e s u l t in sub-

optimal decision making. This rule applies both for origi­

nal design decision making, and the evaluation of alternate

design proposals during the latter phases of the project's

development. The evaluation of alternate building systems

rapidly expands into an enormous problem. Figure 7.5 illus­

trates just nine of the possible designs for a foundation

wall system. Morphological analysis may be u t i l i z e d to aid

in the development of these alternatives. The task of con­

sidering all possible combinations of design systems avail­

able today is astounding. However , in a utopian decision

maki ng environment, none of the designs should be eliminated

for economic reasons until a final evaluation is performed

in the mode 1 .

7_. 2 Life Cycle Cost Estimating

The preparation of a life cycle cost estimate is an

application of general estimating principles. The process

is based on the extension of a quantity by a unit price.


223

DB5ICM

Cast in Place
« 1
Concrete

Precast
# 2

S o lid
# 3

B rick Masonry •
C avity
* 4 foundation

C a v ity w/ Grout Wall


* S

c
Solid
* 6

C avity Concrete Block


# 7

C a v ity v / Grout
« 3

Stone
* 9

Figure 7.5 Possible Foundation Wa l l Alternatives

f
224

The quantity units employed are dependent on the type of

pricing information available. These are usually the units

which are most representative of the cost. For example,

wh e n p r i c i n g out a built-up-roof system, most organizations

develop a system's estimate in terms of $/RSF, where RSF

stands for roof square feet, from h i s t o r i c a l data files for

the type roof involved. A mo r e detailed estimate might

involve the pricing out of each of the individual materials

and labor required. However , even this detailed estimate

may be transformed into a detailed systems estimate by

dividing the cost arrived at by the total number of roof

square feet.

The m a j o r factor defining the difference between a con­

ceptual and a detailed estimate is the a mount of information

utilized by the estimator. A conceptual estimate relies on _

the assumptions of mor e detailed specifications. A detailed

estimate relies on a c t u a l specifications. For example, if

an average unit price/square foot is utilized in the

development of a conceptual estimate, the estimate is depen­

dent upon the assumption that the project meets average

specifications in a l l respects. Conceptual estimates b e c o me

mo r e detailed as mo r e information become s available and

utilized. For example, if the architect decides that the

building will consist of a steel structure, an e x t e r i o r

glazed curtain wall, and o p e n web steel joist floor con­

struction, a mo r e accurate conceptual estimate, based on


225

average unit prices for those specific systems, may be

developed. When a final set of contract documents is

issued, a mo r e detailed estimate is developed by contrac­

tors. Even this estimate is based on a v e r a g e prices from

historical data files and suppliers' quotes.

The p r o c e d u r e for preparing a life cycle cost estimate

is similar to the general procedure described above. The

preparation of a life cycle cost estimate is a mo r e diffi­

cult task in one respect, since there are mo r e costs

involved than an i n i t i a l construction cost estimate. In

fact, a life cycle cost estimate includes the estimation of

initial construction costs. An initial construction cost

estimate contains three major costs, as follows:

1. Material prices, including delivery and warehous­

ing .

2. Labor prices for the handling and installation of

the material.

3. Equipment prices for the handling and installation

of material.

A life cycle cost estimate requires the estimation of

each of these items for initial construction along with ma ny

other costs, as discussed below.


226

7.2.1 Life Cycle Cost Identification

The classification of life cycle costs involves s ome

obscure decisions. Wha t one organization may d e f i n e as a

replacement cost, another may d e f i n e as an a l t e r a t i o n cost,

and yet another as a maintenance cost. The itemization of

life cycle costs for the proposed Life Cycle Costing system

is displayed in Figure 7.6. The definitions b e l o w may a i d

in the classification of life cycle costs:

LCC- 1 Initial Construction Costs: are all the costs

associated with the development of an owner's

concept of a project, from conception through

the construction of the project.

LCC- 2 U s e r Function Costs: are the costs associated

with the use of the building. For example, if

an a l t e r n a t e design for a bank allows three mo r e

teller stations, the user benefit derived from

the three additional stations requires atten­

tion. Another example of user function costs is

denial of use costs. If a construction met hod

prevents occupation for five we e ks longer than

another construction method, then the costs

associated with that delay require recognition.

LCC- 3 M a i n t e n a n c e Costs: are the costs of normal and

systematic preventive maintenance. It is hoped

that the context of this description might help


«

M
M
227

M
W

Fi gure 7.6 Li f e Cycl e Cost Identification


228

in defining the grey area whi ch exists between

maintenance and replacement costs.

LCC- 4 Custodial Costs; are the costs of cleaning and

non-maintenance upkeep. A grey area exists

between maintenance and c u s t o d i a l costs. How­

ever, common sense will help the user to dif­

ferentiate between the two. For example, a

monthly greasing and c h e c k i n g of an air condi­

tioning fan may be considered maintenance,

whereas the cleaning of the air filters may be

considered custodial work.

LCC- 5 E n e r g y and Utility Costs: are the costs of all

forms of energy and o t h e r utilities for the pro­

ject.

LCC- 6 A d m i n i s t r a t i v e Costs: include real estate

taxes, insurance premiums, administrative

personnel's salari.es, and other administration

related costs.

LCC- 7 A l t e r a t i o n Costs: include all costs for future

alterations. The inclusion of this cost allows

the consideration of less permanent construc­

tion, whe n major renovations are scheduled in

the near future .


229

LCC- 8 Replacement Costs: are the costs attributed to

significant replacement of an item in order to

maintain the item's original operations. Th e

definition of significant might be considered

obscure; however, common sense aids in this

classification, too. For example, the replace­

me n t of a light bulb in a fluorescent light fix­

ture may be classified as a maintenance cost,

whereas the replacement of a ballast in the s a me

fixture may be considered a replacement cost.

LCC- 9 Salvage Costs/Benefits: are the costs or bene­

fits associated with the final disposition of

the building, wh e n i t has finished serving its

use to the owner.

LCC- 1 0 Other Costs: is a cleanup category for related

costs otherwise undefined. For example, during

the life cycle cost evaluation of a mechanical

security system, as opposed to security guards,

the cost of the security guards may be classi­

fied as other costs.

7.2.2 For mat and O r g a n i z a t i o n of Estimate

The preparation of the life cycle cost estimate con­

sists of ten individual estimates. Each of the ten

categories of life cycle costs described in Figure 7.6, need


230

to be estimated for each system w ithin the building. A form

such as the one displayed in Figure 7.7 may a i d the user in

the development of these estimates. The form i n Figure 7.7

provides organization for the extension of quantity units by

unit prices for material, labor, and equipment. These costs

are then classified according to time occurrence and rate of

escalation. A symbol, such as AR, 10, or lOr, may be placed

in the time slot to represent annual recurring costs, a l u mp

s um cost in the 10^ year, or a l u mp sum c o s t recurring

every ten years respectively. An estimate of the proper

escalation rate for each i t e m may be estimated. The costs

for each alternate design or construction method, for each

system applicable to the specific project, may be e s t i m a t e d

and summarized on t h i s form.

Th e nomenclature for the labeling of all alternatives

shall be classified according to its Uniformat division

identification number. This number should be used to

represent the design as a variable in the life cycle cost

model.

The net present worth of each alternate requires c o mp u ­

tation, once all the life cycle cost estimates have been

formulated. All the rules and guidelines of economic

analysis, presented in Chapter 4, are applicable. The

owner's profile information, such as tax bracket, discount

rate, capital rationing, and future plans and schedules,

provides part of the information required to model the


I 31

LU

S P“
232

economic environment accurately. The general economic cli­

mate, such as inflation and escalation trends, provides

additional data in order to perform the l i f e cycle cost

analysis accurately.

7_. 3_ Source of Data

One of the three inputs into the Life Cycle Costing

system, owner's profile, has already been d i s c u s s e d . The

other t wo sources of input, which provide the necessary

information for the computation of the life cycle cost esti­

mate, are in the form of databases and procedural refer­

ences. In order to fully expand on these sources of input,

each of the life cycle cost's possible sources will be dis­

cussed .

LCC- 1 Initial Construction Costs: Lump s um initial

construction cost data may be obtained from con­

tractors' historical cost files, cost manuals,

and supplier's quotes. These data sources have

been utilized by the Construction Industry for

ma ny decades, and are readily available. In

order to be compatible with the proposed Life

Cycle Cost system, the data files, which for the

most part are organized in accordance with the

Masterformat, need to be re-organized in accor­

dance with the Uniformat. This will provide

detailed data along a systems format, which is


233

more compatible with the proposed life cycle

cost model.

LCC- 2 User Function Costs: These costs are unique for

each project, and require development, as

opposed to a collective database. A great deal

of information about the operations and produc­

tivity of the operations needs to be collected,

in order to properly attribute costs and/or

benefits with alternative construction designs

and methods.

LCC- 3 Maintenance and LCC- 4 Custodial Costs: These are

annual recurring costs, which require data*

arranged in a formal database. These costs are

dependent on quality of both initial construc­

tion, and on the commitment to upkeep. Specific

requirements of the database are presented

latter .

LC C- 5 Energy and Utility Costs: These are annual

recurring costs which depend on the accuracy of

t wo sets of items. The first set involves the

prediction of the energy demand. These predic­

tions are based on p r i n c i p l e s promulgated by the

American Society of Heating, Refrigerating, and

Air-Conditioning Engineers ( ASHRAE) and the

Illumination Engineers Society (IES). The com­

putations involved in these predictions are


234

becoming mor e accurate and less time consuming

with the advent of computerized systems, such as

the Building Loads Analysis and Systems Thermo­

dynamics ( BLAST) program developed by the Ar my

Corps of Engineers Research Laboratory and the

DOE-II program developed by the Department of

Energy. The second set of items involves the

prediction of inflation and escalation rates for

future energy prices. It should suffice to say

that in a world in which our main source of

energy is controlled by unstable countries, and

more knowledge of ne w e n e r g y sources is being

discovered daily, that the validity and applica­

bility of these predictions are questionable.

Even so, this is the only means of preparing

future estimates for costs of this category.

Each building system will be associated with its

energy load. To p r o p e r l y estimate energy usage,

the alternative may require an interdependent

relationship with another system. For example,

the exterior closure system, Uniformat division

4, accounts for heat losses and gains through

the walls, and solar heat gains through the

fenestration. The cost of the energy loads will

be dependent upon the mechanical system

employed.
235

LCC- 6 Administrative Costs: These costs are unique for

each individual project, and require develop­

ment, as opposed to a collective database. Real

estate taxes are dependent on the percent dollar

assessment valuation and the tax rate of the

local level of government. Insurance is depen­

dent on the ratings of the local police and fire

departments, and the location of the project.

These and other administrative costs require

individual analysis for each project.

LCC- 7 Alteration Costs: Future scheduled and planned

alterations may be estimated based on i n i t i a l

construction cost estimates. Therefore, the

s a me database utilized to estimate initial con­

struction costs, may be employed to estimate

these costs.

LCC- 8 Replacement Costs: A database is required in

order to determine the scheduled and required

replacement for different systems within the

building project. These costs also need to be

prorated for quality of initial construction and

quality of preventive maintenance and upkeep.

LCC- 9 Salvage Value: This is a future l u mp s um p r i c e ,

which is a function of ma ny different items. As

pointed out earlier, the growth in the rate of


236

awareness and concern prospective owners are

expressing in life cycle costs has created a

need for expert assessment of the salvage value.

Salvage value is a benefit and/or cost which is

derived from the quality of construction, level

of maintenance, location, inflation, and supply

and demand principles. Two salvage values

exist: the salvage values of individual systems

once replaced, or at the period in time when the

owner disposes of the building. However, to

estimate the salvage value of each individual

system whe n a n owner decides to sell a building,

ignores three items. First, the value of the

summation of all the building components

together is greater than the sum o f the indivi­

dual building systems' values. This phenomenon

is labeled as the effects of synergism. Second,

the value of a building in s ome locations

increases at a rate higher than the rate of inf­

lation. This results from market phenomena.

Third, prospective buyers are not always willing

to pay more for a building simply because its

life cycle costs promises to be lower. These

three items should be conservatively estimated

and accounted for.


237

LCC- 10 Other Costs: These costs are developed and

estimated for each i n d i v i d u a l project, and

therefore require no database.

According to the d i s c u s s i o n presented above, pertain­

ing to the source of l i f e cycle cost data, only LCC-

1,3,4,7, and 8 require information which is best

organized by the use of a database. These life cycle

costs are as follows:

LCC- 1 Initial Construction Costs

LCC- 3 M a i n t e n a n c e Costs

LCC- 4 Custodial Costs

LCC- 7 Alteration Costs

L C C- 8 Replacement Costs

The databases required for LCC- 1 and LC C- 7 are readily

available. However, there a r e few databases in existence

for LCC-3, LCC-4, and LCC-8, as discussed below.

7_.4_ Current Da t a b a s e s Available

The proposed Life Cycle Cost system operates within the

s a me GIGO principles as a computer program does. The GIGO

rule states that if garbage is fed into the system, the sys­

tem shall return garbage out. Stated differently, the

results the Life Cycle Cost system yields are dependent upon
238

the input fed into it. As initial construction cost data,

which is utilized in developing estimates for both initial

construction (LCC-1) and alteration (LCC-7) costs, is

readily available, the following discussion pertains to

maintenance (LCC-3), custodial (LCC-4), and replacement

(LCC-8) costs. Previous methods of estimating these costs

were dependent on e s t i m a t i n g them as a percentage of origi­

nal costs. Although these three life cycle costs may be

developed for each project individually, a database would

provide mor e accurate, mor e consistent, and less time con­

suming results. Currently t wo databases have been developed

which are available to Life Cycle Cost system users.

The first database, which is described as an 'industry

first attem pt', wa s developed by A l p h o n s e D ell'Isola and

Stephen Kirk. Their book, 'Life Cycle Cost Data', wa s pub­

lished in 1983, and provides data on a n n u a l maintenance

costs, replacement lives, and the cost of replacement as a

percentage of original cost. [81] Maintenance costs, as they

define them, include custodial, repair, contract mainte­

nance, and maintenance staff costs. The combination of cus­

todial and maintenance costs presents no problem of compati­

bility with the proposed Life Cycle Cost system. In fact,

without considering the quality of D ell'Isola's and Kirk's

data, their database satisfies the requirements of the data­

base needed to complete the input for the proposed system.

Data is organized and classified in terms of the Uniformat.


239

The format for presenting this information is s hown in Fig­

ure 7.8. [82] This database compiles information f r o m more

M a in te n a n c e a n n u a l c o s t . $ E n e rg y R e p la c e ­
U n t of dem and m e n t life, 4>.

I te m d e s c r ip tio n m e a su re M a i n t e n a n c e d e s c r ip tio n L a b o r I M a te r ia l ' E q u ip m e n t (E U ) y rs R e p la c e d

U s e d to d o c u m e n t U N IF O R M A T G iv e n U s e d to d e s c r i b e s p e c ific 1 I 2 I 3 4 5 6
c a t e g o r y a n d d e s c r i b e s p e c ific for m a in t e n a n c e t a s k s a n d 1 U s e d to c o n v e r t la b o r h o u r s in to a n n u a l c o s t s
fa c ility ite m s a n a ly z e d . each c o r r e s p o n d in g la b o r 2 U s e d t o c o n v e r t m a te r ia l r e q u ir e m e n ts in to a n n u a l c o s t s
ta s k p e rfo rm a n c e 3 . U s e d to c o n v e r t m a in t e n a n c e e q u ip m e n t in to a n n u a l c o s t s
s ta n d a rd (s ) 4 U s e d to r e c o r d e n e r g y c o n s u m p tio n r e q u ir e m e n ts fo r th e
fac ility n e m s .
5 U s e d to d o c u m e n t r e p l a c e m e n t life o f sig n ific a n t
c o m p o n e n ts o f fac ility ite m s
6 U s e d to e s t i m a t e p e r c e n t o f fa c ility ite m c o s t r e p l a c e d a t
t h e y e a r s p e c if ie d ( s e e R e p la c e m e n t lif e )

Figure 7.8 D ell'Isola's and Kirk's LCC D a t a b a s e

* Reprinted from 'Life Cycle Cost Data'.

than 24 d i f f e r e n t sources of data, as shown in Figure 7.9.

[83]

The second database has been, and is presently, being

developed by the Ar my Corps of Engineers Construction

Engineering Laboratory. Research concludes that data col­

lection of maintenance and repair costs for a r my installa­

tions is not feasible at this time. This is because records

of the army's buildings and their characteristics lack the

necessary detail to develop a complete life cycle cost data­

base. Therefore, the research concludes that a life cycle

cost database is best developed by Engineered Performance

Standards (EPS). Th e following is a general outline of the

steps utilized by the Engineered Performance Standards

method to develop maintenance and repair data for building

components [ 84 ] :
240

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241

Figure
242

continued
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243

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244

EPS METHOD FOR DEVELOPI NG BUI LDI NG COMPONENT M&R DATA

1. A schedule of preventive maintenance ( PM) is determined

using the manufacturer's recommendations, the

contractor's experience, and other sources.

2. Each preventive maintenance job is broken down into

tasks, and the manpower requirements for each task are

determined using Engineered Performance Standards.

3. The expected failure rate of t h- . component is used to

determine frequency of repairs.

4. Each repair job is tasked, as in No . 2 above.

5. Material requirements are calculated for each preven­

tive maintenance or repair job.

6. Yearly total manpower and material requirements are

calculated.

Steps it2 a n d 4 utilize a method of developing life

cycle cost data entitled Engineered Performance Standards.

The Engineered Performance Standards method of developing

life cycle cost data operates as follows:

EPS METHOD FOR DEVELOPI NG L I F E CYCLE COST DATA

1. A system or sub-system is broken into its components

and sub-components. Those requiring maintenance are

listed with the required maintenance actions. Expected


245

failure actions are also listed.

2. Each maintenance and repair action is broken into

tasks; the manpower requirements for each task are

determined using Ar my E n g i n e e r e d Performance Standards.

Concurrently, required quantities of materials and sup­

plies are determined, and their cost is expressed in

either man-hours or percent of the component's initial

costs .

3. Frequencies are established for the maintenance actions

and for failures. These are based on m a n u f a c t u r e r ' s

data, available experience, ASHRAE, and similar organi­

zations' publications, and engineered judgement.

4. Yearly total costs are computed in man-hours, or in

man-hours and percent of initial cost. If costs are

expressed in man-hours and percent of initial costs,

the database will not require updating because of inf­

lation.

5. Steps 1 through 4 are done for 25 years. Yearly infor­

mation is useful for backup data, and designers use the

average yearly maintenance cost for their purposes.

For cyclical repair actions, the cost and the cycle

(years) must be put into the database.

The Uniformat method of cost coding facility com.ponent s

and sub-components, is employed in the design of the


246

database. Maintenance is defined, by the researchers, as

scheduled preventive maintenance and custodial costs, while

repairs are defined as unscheduled maintenance costs.

A s u mma r y of current research performed by the Con­

struction Engineering Research Laboratory on the topic of

life cycle cost database development is as follows [85]:

1. Design of a database for each of the following five

building components:

A. Heating, Ventilating, and Air-Conditioning

( HVAC)

B. Floor Covering

C. Roofing

D. Interior Finishes

E. Exterior Finishes

2. Development of data for:

A. Partial data developed for HVAC s y s t e m s .

B. All data developed of floor covering systems.

3. Ongoing research in completing the development of data

for the remaining systems.


247

Ma ny other organizations have initiated programs for

the collection and classification of life cycle costs. How­

ever, these programs catalog the costs in terms of type of

expense, such as the Building Owners and Managers Associa­

tion does, as opposed to correlating the information to

building systems, as the t wo organizations above have.

7_.5_ Requirements of a_ L i f e Cycle Cost Database

The performance requirements of a life cycle cost data­

base which supports the proposed Life Cycle Cost system, are

as follows:

1. The database needs to be organized in a building sys­

t ems cost coding format, which is fully compatible with

the Life Cycle Costing system.

2. Th e database needs to contain stratified information,

so that it can satisfy the requirements of both a con­

ceptual and a detailed Life Cycle Cost system.

3. The database needs to contain information which is con­

sidered appropriate and reliable for the environment

peculiar to various building construction projects.

4. Th e database shall be protected, as best it can, from

the effects of inflation.

5. Th e database needs to be able to be developed as prac­

tically and easily as reasonably possible.


248

CHAPTER 8

PROPOSED L I F E CYCLE COST DATABASE DEVELOPMENT

The Construction Industry has only recently begun to

realize the importance of developing life cycle cost data­

bases. As mentioned earlier, the development of t wo data­

bases within the past t wo to three years has spear-headed

the Construction Industry's quest for collecting and organ­

izing life cycle cost data.

Two m e t h o d s for developing life cycle cost databases

include the use of historical accounting data, or the

development of engineered or scientific data. This chapter

explores these means for developing life cycle cost data­

bases .

JL*-L Life Cycle Cost Database Preface

Th e life cycle cost data requiring collection and

organization into database format are:

LCC- 3 Annual Maintenance Costs

a. Material Costs
249

b. Labor Costs

c. Equipment Costs

d. Sub-Contractor Costs

e. Task Description

LCC- 4 Annual Custodial Costs

a. Material Costs

b. Labor Costs

c. Equipment Costs

d. Sub-Contractor Costs

e. Task Description

LCC- 8 Replacement Costs

a. Material Costs

b. Labor Costs

c. Equipment Costs

d. Sub-Contractor Costs

e. Task Description

f. Replacement Cycle or Period

A database containing the level of detail shown above

allows the user various flexibilities such as:

1. Mo r e latitude in deciding whether a database cost

item is applicable to the system and environment

being examined.

2. Mo r e flexibility in the modification of certain

costs, in order to properly model the environment.


250

3. Greater power in developing ne w c o s t data.

The itemization of the data in the level of detail shown

above is optimal, however, not absolutely necessary. Since

the division of custodial costs and maintenance costs is not

required, these t wo costs need not be separately classified.

In addition, since the separation of m aterial, labor, and

equipment is not essential, that portion of the level of

detail may a l s o be eliminated. A reasonable modification of

the level of detail might resemble the following pattern:

LCC-3,4 Annual Custodial and M aintenance Costs

a. Total Costs

b. Description

LCC- 8 Replacement Costs

a. Total Costs

b. Description

c. Replacement Period

In order to promote compatibility between the proposed

Life Cycle Cost system and the database, the Uniformat

method of cost coding may be employed. The systems classif­

ication of construction costs is far superior to trade clas­

sification wh e n evaluating construction designs and methods.

In addition, the Construction Industry has already started

employing the Uniformat for initial construction cost cod­

ing. Therefore, the use of this cost coding format would

tie together the estimation of initial construction costs

and life cycle costs.


Incorporation of the life cycle cost data coding with

the Uniformat notation is similar to the method of cost cod­

ing described in Figure 6.2. The life cycle cost data code

is a distribution code which is tacked onto the end of the

Uniformat cost code. An a p p l i c a t i o n of this method of cost

coding for vinyl wall covering on the interior of an exte­

rior wall system (Uniformat identification code number

06211g01) would be as follows:

06211g01L3a Annual Maintenance Material


Co s t s

06 2 1 1 g 0 1 L 3 b Annual Maintenance Labor Costs

0 62 11 g01L3c Annual Maintenance Equipment


Cos t s

06 2 1 1 g 0 1 L 3 d Annual Maintenance Task Descrip-


tions

06211g01L4a Annual Custodial Material Costs

0 6 2 1 1 gO 1 L4b Annual Custodial Labor Costs

06211g01L4c Annual Custodial Equipment Costs

06211g01L4d Annual Custodial Task Descrip-


tions

06 2 1 1 g 0 1 L 8 a Annual Replacement Material


Cos t s

06211g01L8b Annual Replacement Labor Costs

06 211g01L8c Annual Replacement Equipment


Costs

06 2 1 1 g O l L 8 d Annual Replacement Task Descrip-


t i ons

06 2 1 1 g 0 1 L 8 e Annual Replacement Periods

The letter L and t wo characters following it are the life

cycle cost distribution codes. These life cycle cost codes


252

are c o n s i s t e n t with the m e t h o d of life cycle cost cod i n g

presented earlier.

Conceptual data is required in order to prepare life

cycle cost estimates for construction projects in the con­

ceptual design phase. Without detailed design information,

the conceptual life cycle cost data must represent an aver­

age of the most c ommon or probable designs. In order to

achieve this level of life cycle cost data, an average of

the life cycle costs of the most probable and/or c ommon sub­

systems may be utilized. This average sub-system life cycle

cost can be u s e d until further design detail for the project

is achievable. Other conceptual estimating techniques, such

as parametric estimating, may not be employed until more

life cycle cost information becomes available.

The u n i t s employed i n the database remain a very impor­

tant topic. Several choices of units for data collection

and storage exist; a few of these are as follows:

1. $/square foot

2. % of initial construction costs

3. man-hours/ square foot

The units which lend themselves to life cycle cost field

data collection are as follows:

1. Material costs are best collected in $/square foot

units.
253

2. Labor costs are best collected in man-hour/ square

foot units.

3. Equipment costs are best collected in $/square

foot units.

However, in order to provide a certain degree of uniformity

and to protect the database from inflation, the optimal

units which should be employed are man-hours/square foot.

Material and Equipment costs can be converted to man-hours

of related labor/square foot in the year the database is

developed and, assuming that the costs of labor, materials,

and equipment experience the s a me inflation rate, the data­

base will be protected from the effects of inflation. To

use the database, the user should simply multiply the man-

hour/square foot figure by the cost/man-hour of labor for

the current year. Tables of up-to-date labor rates for

building maintenance trades, such as the one shown in Figure

8.1, should be kept. [86]

If several trades of labor are used for one work item,

then all of the distribution codes will require conversion

to one of the trades, which will be noted in the descrip­

tion. Either one of the trades may be chosen as the base

trade. For example, if a heating unit requires 15 m a n - h o u r s

of maintenance work @ $20/hour and 20 m a n - h o u r s of appren­

tice work @ $ 1 0 / h o u r annually, then the total annual labor

cost is $500. This annual labor cost is equivalent to 25

man-hours of full maintenance labor or 50 man-hours of

apprentice labor.
254

San
Trade w a g e ( $ / h ) Chicago Francisco Denver N e w York Averag

Janitorial:
B ase w a g e 6 .9 0 9 .0 4 4 .7 7 7 .7 6
Fringe benefits 1 28 2 .0 8 .7 2 1 .4 8
Total 8 .1 8 1 1 .0 2 5 .4 9 9 .2 4 8 .4 8

Janitorial
(S p e c ia l):
B ase w a g e 7 40 Not Not Not
Fringe benefits 1 .28 reported reported reported
Total 8 .6 8 8 .6 8

O perating
engineers:
B ase w a g e 1 3 .6 5 1 3 .0 0 1 0 .0 0 1 3 .9 2
Fringe benefits 2 .4 8 2 .5 7 1.77 5 .5 0
Total 1 6 .1 3 1 5 .5 7 1 1 .7 7 1 6 .4 2 14 9 7

Elevator operators:
B ase w a g e 7 20 9 .0 4 Not 7.11
Fringe benefits 1 .4 0 2 .0 4 reported 1 .4 0
Total 8 .6 0 1 1 .0 8 8 .5 1 9 .4 0

Elevator starters:
B ase w a g e 7 50 9 .1 5 Not 7 62
Fringe benefits 1 .4 3 2 .0 4 reported 1 .4 6
Total 8 .9 3 1 1 .1 9 9 .0 8 9 73

Security:
B ase w a g e 6 .3 5 Janitor's 4 .7 7 7 11
Fringe benefits 1 .34 responsibility 72 1 40
Total 7 .6 9 5 49 8 .5 1 7 23

M aintenance
electricians:
B ase w a g e 1 1 .2 5 Included 1 6 .1 0 15 75
Fringe benefits 1 .85 with 2 .9 7 2 .3 6
Total 1 3 .1 0 engineers 1 8 .8 9 18 11 16 70

Fixture cleaners, relampers:


B ase w a g e 8 90 Janitor's Janitor's E lectrician's and
Fringe benefits 1 .6 9 responsibility responsibility janitor's
Total 1 0 .5 9 responsibility 10 59

W indow w ashers:
B ase w a g e 7 99 11 9 2 8 85 N ot
Fringe benefits 1.28 2 .6 4 1 33 reported
Total 9 .2 7 1 4 ,5 6 1 0 .1 8 11 3 4

Firem en and oilers:


B ase w a g e 1 1 .3 8 Not Not N ot
Fringe benefits 1 .93 reported reported reported
Total 13.31 13 31

Figure 8.1 1981-1982 B u i l d i n g Maintenance Trade Wa g e


Information*

* Reprinted from "Life Cycle Cost Data".

I
255

Although replacement costs can also be represented in

man-hours/ square foot, s o me users might opt to employ the

costs in units employing percent of initial construction

costs. Since replacement costs were defined as major

material replacement, percent of initial construction cost

might be a m o r e representative unit for replacement costs.

8_. 2_ Data Development

An i m p o r t a n t component of the proposed Life Cycle Cost

system is the life cycle cost database. The accounting and

engineered methods of data development have been employed by

the Construction Industry throughout several decades for the

development of initial construction cost data. The follow­

ing discussions will briefly describe and contrast the t wo

methods, as applied to the development of life cycle cost

data. For each of the methods, the development of average

life cycle cost data will be presented; discussions on pro­

cedures available to adjust this data for specific environ­

ments are presented later.

8.2.1 Accounting Method

The accounting method of developing life cycle cost

data may be employed to produce a historical life cycle cost

database. It is a procedure for the retrieval and classifi­

cation of actual field data. This is the most c ommon mea ns


256

for developing initial construction cost data within the

Construction Industry.

The accounting method involves a cost accounting system

entitled 'Job Ordered Accounting'. This procedure involves

the accumulation of costs from projects, and the application

of project costs to the building components within the pro­

ject. Actual life cycle cost data is collected through the

use of field data collection forms. Material requisition

forms are used to charge each building system for materials

used. Wo r k tickets, c ommonl y referred to as time tickets or

time cards, and different than the clock cards used for pay­

roll accounting purposes, are used to charge each building

system for equipment and labor used. These work tickets

itemize the amount of time of each workman's day spent on

each building system. The information gathered through

field data collection forms is brought into the office and

accumulated by job-cost sheets, and then assigned to subsi­

diary ledgers representing building systems. [87] Th e

specific building system's ledgers are assigned Uniformat

identification numbers, through which maintenance and custo­

dial information is compiled annually.

Replacement costs and periods must also be collected.

In order to do this, the life cycle cost collection system

must be employed for a sufficient period of time during

which the systems within the building might be replaced.


257

D ell'Isola and Kirk propose that certain building systems

may endure as mu c h as 100 years of use before requiring sub­

stantial replacement. [88] However, as illustrated in

Chapter 6, very little accuracy in the life cycle cost cal­

culations is gained by charting a cost past 20 years. In

addition, 20 years seems a sufficient amount of time to

account for age effects on maintenance costs. These t wo

characteristics help conclude that 20 y e a r s might be a suf­

ficient amount of time for collecting life cycle cost data

from a construction project. Incidental historical costs,

or the engineered method of developing data, may be used to

develop replacement costs which occur after the 20 year col­

lection period.

The following formula may be employed in order to

determine the number of samples required for each building

system: [89]

z
Ti.il
• n - ^ -*J
, — (8 . 1)
h
whe r e :

n is the needed sample size for each building sam­

ple .

h is the desired half-width of the confidence inter­

val .

1-a is the confidence coefficient.


258

o is the planned standard deviation of the entire

population of the building systems.

For example, if a 95% c o n f i d e n c e coefficient, a half-width

of $ .20, and a planned standard deviation of the population

of Stated differently, a sample size, for a population with

a standard deviation of .5, of 24 is required, in order to

determine a mea n life cycle cost ± $.20 with a 95% confi­

dence coefficient. If all the systems' data conformed to

the assumptions listed above, a great number of buildings

must be sampled in order to derive 24 s a m p l e s of each possi­

ble building system design.

8.2.2 Engineered Method

The engineered, or otherwise known as scientific,

method of data development has been used by the Civil

Engineering Research Laboratory, at Champaign, Illinois, and

D ell'Isola and Kirk, for the development of their life cycle

cost databases. This method involves the definition and

analysis of the maintenance, custodial, and replacement

tasks.

Maintenance, custodial, and replacement tasks may be

defined through a combination of any of the following

sources:

1. Interview Field Forces: Field maintenance foremen

and superintendents may be interviewed.


259

Conclusions yielded from these interviews will

require screening for bias before adoption.

2. Experience and Common J u d g e m e n t : Persons develop­

ing the data may u s e valuable personal experience

and judgement in developing task descriptions.

3. Spec-Data: The Construction Specifications Insti­

tute has developed a series of manufacturers

descriptions of building materials organized along

the Masterformat system of cost coding. These

descriptions include maintenance descriptions that

can prove very helpful in developing system

maintenance descriptions. These descriptions may

also be biased, however.

4. M anufacturer's Data and Representatives: Data

which can not be found in the Spec-Data series may

be derived from individual suppliers. These

descriptions may a l s o be biased.

5. Trade Magazines and Manuals: Building maintenance

magazines and manuals are available and may pro­

vide very helpful information.

6. Architects Operation and Maintenance Project

Manual: It is very common for architects to pro­

vide an operation and maintenance manual for the

owner prior to project occupation. These manuals


usually provide very good input on large equipment

m aintenance.

The descriptions of m aintenance, custodial, and replacement

require completeness and should be representative of common

practice .

On c e a t a s k description has been completed, labor,

m aterial, and equipment requirements must be estim ated. The

sources listed above are very good r e f e r e n c e s for aiding in

the development of these estim ates.

Labor requirem ents c a n be estim ated through building

trade productivity data, which can be found in governmental

m aintenance manuals, trade magazines and m a n u a l s , and field

forces, among others. In addition, several models and

management systems for analyzing labor requirem ents are

available. Applicable techniques include motion analysis,

work sampling, and process charts. Any of these methods may

be employed in developing man-power requirement estim ates

for each task defined in the task descriptions.

M aterial requirem ents can best be estim ated through

interview ing field forces, m anufacturer's data (both for

systems and m aterials), and trade magazines, a mong others.

M aterial quantities and prices should be e s t i m a t e d and c o n ­

verted to man-hours as previously examined.

Equipment requirem ents are best estim ated by interview ­

ing field forces. Equipment costs mainly involve the


261

depreciation or rental expense of the equipment. These

should be e s t i m a t e d , and a l s o converted to man-hours.

i
!
8.2.3 Accounting vs. Engineered Data Development

Both methods of life cycle cost database development

c a n be described as feasible. However, both methods possess

disadvantages and a d v a n t a g e s . These shall be p r e s e n t e d and

discussed below.

A c c o u n t i n g Method

Advantages

1. A ctual Data: The d a t a collected is a c tu a l data,

which adds an important degree of confidence to

the data.

2. F a c to r Development: The data may be used to

develop factors and indices required to properly

model the environment.

Disadvantages

1. Size and Ti me of D e v e l o p m e n t : The number of

buildings and length of data collection needed to

develop the database nearly forces this method to

be classified as infeasible.

2. Data Collection: All the disadvantages of field

data collection, such as bias and inaccuracies,

are applicable.
262

3. Divergent Environments: Defining the exact

environments of the sample buildings can be a v e r y

arduous task.

4. Labor Units: Th e database is based on a labor

productivity standard. Labor productivity harbors

a great deal of waste. Thus, if productivity is

improved, the database becomes dated.

5. Volunteers: With the amount of work involved in

such a large development, finding volunteers to

partake in the development may prove to be a

futile effort.

Engineered Method

Advantages

1. Simpler Development: Th e engineered method prom­

ises to be e a s i e r to develop.

2. Simpler Update: With the fast development of new

building m aterials, the engineered method promises

to be e a s y to u p d a t e .

Disadvantages

1. Incomplete S o u r c e s : , The sources for input infor­

mation may be incom plete.

2. Non-Actual Data: A degree of confidence in the

data is risked without actual field data collec­

tion.
263

3. Common P r a c t i c e : Defining maintenance tasks which

can be classified as common p r a c t i c e seems ques­

tionable .

8_. 3^ D a t a Ad j u s t m e n t

Several factors affect the quantity of maintenance,

custodial, and replacement costs in building construction.

A method for protecting the database from one of these

influencing factors, inflation, has already been presented.

Methods of adjusting the data for other influencing factors

shall also be discussed.

The factors which effect life cycle costs are sim ilar

to the ones which influence initial construction costs.

They are as follow s:

1. Locat ion

2. Labor Productivity

3. Q uality of Initial Construction

4. Q uality and Commitment to Upkeep

5. Quality of Occupation of the Project

These factors may be a c c o u n t e d for by the im plem entation of

either indices or a d j u s t m e n t factors.

Many d i f f e r e n t methods for developing these indices

exist. In order to check the indices or adjustment factors


264

once they have been approximated, actual field data would

need to be collected. Indices involve changing an index,

which models costs, from the average environment utilized in

the database to a specified one. Indices operate according

to either Equation 8.2 or E q u a tio n 8.3, depending on the

s i t u a t ion .

'env-1
LCC . = LCC , _ , (8 . 2)
env-1 database
databas e

'env- 1
LCC . = LCC 0 (8.3)
env-1 env-2
'env-2
whe r e :

env-1 is a new c o n s t r u c t i o n project environment, which

a cost is being developed for.

env-2 is an old construction project environment, which

is being used for cost collection.

I is an index which models a specific environm ent.

Factors are used for adjustment of the data to model

the specific environment, as shown i n Equation 8.4.

LCC L C C J (8.4)
env-1 d a „t a bV. a s e *

whe r e :

env-1
V =
'database
265

Th e life cycle cost data can be a d j u s t e d for location

through the use of a location index. Location indices for

initial construction costs are readily available in con­

struction cost manuals. If these prove to be inaccurate,

life cycle cost location indices may be d e v e l o p e d by model­

ing a representative set of common m a i n t e n a n c e costs in


various locations.

Labor productivity, which is affected by many different

factors, can be a d j u s t e d through the use of efficiency fac­

tors. Louis D allavia has developed production efficiency

factors, which are displayed in Figure 8.2, for estim ating

construction labor productivity. [90] Factors such as these

may be developed for building maintenance and custodial

trades .

Quality factors may be e m p l o y e d to adjust life cycle

cost data for quality of initial construction, commitment to

upkeep, and q u a l i t y of occupation. These factors may b-e

roughly estim ated until actual data is collected and

a n a l y z ed .

As mo r e actual data is collected and organized, factors


t
and indices for these influences, and others, may be

developed. In order to collect the necessary data about the

location, quality, and other building descriptions, building

descriptors, such as the ones shown i n Appendix B, should be

kept for each sample building comprising the actual data.


266

P ro d u ctio n efficien cy, p e r cent


P ro d u ctio n 25 35 45 55 65 75 80 85 90 95 100
e le m e n ts Low Average H igh
1 G eneral ec o n o m y prosperous n o rm a l h a r d tim es
local business trend stimulated normal depressed
construction volume high normal low
unemployment low normal high

2 A m o u n t o f w o rk lim ite d average extensive


design areas unfavorable average favorable
manual operations limited average extensive
mechanized operations limited average extensive

3 Labor poor average good


training poor average good
pay low average good
supply scarce normal surplus
4 S u pervision poor average good
training poor average good
pay low average good
supply scarce normal surplus

5 Job c o n d itio n s poor average good


management poor average good
site and materials unfavorable average favorable
workmanship required first rate regular passable
length of operations short average long
6 W ea th er bad fair good
precipitation much some occasional
cold bitter moderate occasional
heat oppressive moderate occasional

7 E q u ip m e n t poor n o rm a l good
applicability poor normal good
condition poor fair good
maintenance, repairs slow average quick

8 D elays n u m e ro u s som e m in im u m
job flexibility poor average good
delivery slow normal prom pt
expediting ooor average good

Figure 8.2 Construction Productivity Efficiency Factors*

* Reprinted from " E s t i m a t i n g General C onstruction Costs".


267

These building descriptors w ill allow accurate analysis and

modeling of influencing factors, trends, and correlations

among life cycle cost data.


268

CHAPTER 9

UNCERTAINTY OF L I F E CYCLE COST ESTIMATES

Two m e t h o d s of developing life cycle cost databases

were presented in the previous chapter, along w ith a discus­

sion of the advantages and disadvantages of each. Methods

of adjusting life cycle cost data to better fit the specific

environment being analyzed, were also presented. However,

consideration of all the factors which influence life cycle

costs infers that data collected and developed w ill be

highly variable in nature. Methods of describing and deal­

ing with the variability of the life cycle cost data for

both database development and preparation of life cycle cost

estim ates, are presented below.

9_._1_ Uncertainty

In financial literature, uncertainty is a term which

refers to a situation in which one is unable to attach a ny

probability values to possible outcomes. A related term,

risk, describes a situation in which probability may be

assigned to each possible outcome. Therefore, in a strict


269

sense, risk and uncertainty define different environm ents.

[91] However, for the purposes of this discussion, both risk

and uncertainty are employed to define a situation in which

param eters, and u l t i m a t e l y outcomes, are associated with

variability.

A common m e t h o d of dealing with the uncertainty associ­

ated with life cycle costs is to employ conservative esti­

mates. However, ignoring the variability of these estim ates

deprives the owner of an a c c u r a t e analysis of all available

potential cost saving opportunities. Several methods of

handling the uncertainty associated with life cycle costs

will be presented in the next section. These methods may b e

utilized during the development of a life cycle cost data­

base, or a f t e r w a r d s , during the preparation of life cycle

cost estim ates.

The m e t h o d s are applicable to both historical account­

ing data and e n g in e e r e d (or scientific) data, and the level

of detail at which they are employed is optional. Con­

sideration of variability at the labor, m aterial, and equip­

ment level seems im practical. System and subsystem levels

might be mo r e reasonable levels of detail at which variabil­

ity and uncertainty effects are assessed.


270

9_.2^ Methods of Describing U ncertainty

All the methods presented below a re viable methods of

describing the uncertainty of a system 's life cycle costs.

The s p e c i f i c method the user employs depends upon the infor­

mation required, and the u ser's preferences. Each method

yields unique results, which are all applicable toward a

better understanding and appraisal of the life cycle costs

involved.

In order to better illustrate s o me of the methods

presented below, an example system w ill be referred to. Th e

system 's life cycle costs are described in Table 9.1. For

Table 9.1 Example System

LCC I t e m D escription Cost


LCC- 1 Initial Costs $20 , 0 0 0
LCC —2 User Function Costs N/ A
LCC- 3 Maintenance Costs N/ A
LCC- 4 Custodial Costs $200
LCC —5 Energy & U tility Costs $3 , 0 0 0
LCC —6 A dm inistrative Costs N/ A
LCC —7 A lteration Costs N/ A
LCC- 8 Replacement Costs N/A
LCC- 9 Salvage Costs/B enefits n/ a

LCC—10 Other Costs N/ A


A Total Annual Recurring Costs $3,200
I Total Initial Costs $20 , 0 0 0
n Useful Life 20 y e a r s
i% Discount Rate 15%
sim plicity, only three of the ten life cycle cost classifi-

cations are employed.

9.2.1 Sensitivity Analysis Method

Sensitivity analysis involves the determ ination of the

effects of substituting different values for the parameters

of an e c o n o m i c analysis. This method may be employed to

determine the parameter variation effects on e i t h e r the

equivalent uniform annual value or the net present value of

a system. One t e c h n i q u e for displaying the effects of cer­

tain parameters is to develop fam ilies of curves, such as

those presented in Figure 9.1. These curves display a great

deal of inform ation with respect to the effects of uncer­

tainty in a system 's l i f e cycle cost param eters. Th e

effects of variation of i n t e r e s t rate, initial cost, and

usefullif e may be seen quite readily. The e f f e c t of a

variation in either of the t wo annual recurring costs is

equal to the variation of the parameter itself, and do n o t

require re p re s e n ta tio n in the curves. Th e curves are

developed by p l o t t i n g the results of successive substitution

of increasing or decreasing values of the parameters into

the economic equation defining the system.

a.
A second technique for displaying the single parameter

variation effects on t h e total life cycle cost estim ate of a

system, is a graphical representation of the percent vari­

ance in parameter vs. the percent variance in net present


272

1.000
E
U n=15

A
C i.OOO n=15

n«20

n=20

$4,000
0.00 0.12 0.16 0.20 0.24

INTEREST RATE

Figure 9.1 Sensitivity Family Curves

f
273

value (or equivalent uniform annual value) relationship of

the system. An i l l u s t r a t i o n of this method, for the example

system, is presented in F ig u re 9.2. One l i m i t a t i o n of this

method, which is not a characteristic of the previous

method, is that the effects of m ultiple variation a mong

several of the parameters can n o t be r e a d i l y derived from

the curve. This query ma y be overcome by graphically

displaying fam ilies of curves, representing the m ultiple

variation effects that the parameters might have on the

economic evaluation.

Either one of the above two m e t h o d s may be e m p l o y e d in

order to s a t i s f a c t o r i l y observe the effects of v a r i a t i o n in

the constituent parameters on the total life cycle cost

estim ate. This technique for observing the uncertainty

associated with a system 's life cycle costs does not require

any previous knowledge about the probability of the variance

associated with constituent parameters, or the system 's

total life cycle cost itself.

9.2.2 Range Estim ate Method

A range estim ate for each of the parameters allows the

derivation of an a v e r a g e life cycle cost estim ate for each

system. A range estim ate consists of an estim ate for the

most optim istic values (best case), mos t pessim istic values

(worse case), and the most likely values. Onc e these values

are computed, averages of all three estim ates are taken.


274

CUSTODIAL COSTS

0.10

CNCRCY COSTS
m oz> ~D > <

0.05
INITIAL COSTS

USEFUL LIFE
z~

INTEREST RATE

•0.05
<*oz

- 0.10

-30 -20 -10 10 20 30

% VARIANCE IN PARAMETER

Figure 9.2 Sensitivity Percent Variance Curves


275

Two d i f f e r e n t techniques of averaging may be u t i l i z e d .

The f i r s t technique, horizontal averaging, requires the

computation of an a v e r a g e value for each parameter. A net

present value is computed for the resulting average case.

The s e c o n d technique, vertical averaging, requires the

computation of a net present value for each of the three

cases. Next, an a v e ra g e of the net present values for the

three cases is computed.

An illustration of both of these techniques is

displayed in Figure 9.3. Neither of these t wo t e c h n i q u e s

can be a c c r e d i t e d with theoretical superiority. In fact,

both techniques are approximately equivalent, and either

result may be labeled as the most likely or average value.

9.2.3 Expected Value Method

The e x p e c t e d value method is a third method useful in

describing the uncertainty associated with a system 's life

cycle costs. This method is very sim ilar to the range esti­

mate method presented earlier. However, it is superior to

the range estim ate method in that it accounts for the vari­

ability pattern of the three cases. The e x p e c t e d value

method proposed below employs the logic of the Project

Evaluation and Review T e c h n iq u e s (PERT), which is a proba­

bilistic modeling technique employed in project scheduling

and, mo r e recently, in range estim ating of initial

construction costs.
27 6
277

An e x p e c t e d me a n (t ), a standard deviation ( at ), and


e
a variance (v ) are computed using a weighted average, as
e
shown i n Equations 9.1, 9.2, and 9.3 respectively.

t + 4t + t,
te = — r5 ( 9 *1}

°t ( 9 ‘ 2)
e

t, - t I 2
b a
(9.3)
vt = (ot )2
e e 6 J
whe r e :

t is the most likely estim ate.

t is the 1% o p t i m i s t i c value.

t^ is the 99% p e s s i m i s t i c value.

t is the most likely value,


m

These formulas assume that a probability distribution curve

describing the situation is a beta distribution. [92]

Moder and Phillips have developed an E q u a tio n for a ,


e
which averages the distribution types, ranging from E x p o n e n ­

tial to Normal, and including Rectangular, Triangular, and

Beta. Their equation of a' is as follows: [93]


whe r e :

t is the 5% optimistic value.

t^ is the 95% p e s s i m i s t i c value.

This second technique for computing the standard deviation

of the distribution is preferred over the earlier technique,

since i