Life Cycle Cost or Whole-Life Cost

By 
KATELYN PETERS
 
 
Updated Oct 5, 2020

What Is Whole-Life Cost?

Whole-life cost is the total expense of owning an asset over its entire life, from purchase
to disposal, as determined by financial analysis. It is also known as the life-cycle cost,
the lifetime cost, "cradle to grave," or "womb to tomb." Whole-life cost includes purchase
and installation, design and building costs, operating costs, maintenance, associated
financing costs, depreciation, and disposal costs.

Whole-life cost also takes into account certain costs that are usually overlooked, such
as those related to environmental and social impact factors.

Example: In constructing a nuclear power station, it is possible to calculate the

environmental impact of making the concrete containment and the water required for
copper refinement, in addition to other components.

Whereas a number of options may be portrayed as "good" for the environment, a whole-
life cost analysis allows a determination of whether or not one solution carries a lower or
higher environmental cost than another.

Understanding Whole-Life Cost Analysis

Whole-life cost analysis is often applied when evaluating different options when
investing in new assets and for analyses that attempt to minimize whole-life cost over
the lifetime of an asset. It may also be used to decide between two different projects or
to make acquisition decisions.

When comparing investment decisions, a financial analyst must look at all potential

future costs, not just acquisition expenses. Typically, the focus is on the up-front capital
costs of creation or acquisition, and many organizations fail to take into account the
longer-term costs of an asset. Without considering whole-life costs, it's possible that an
asset’s return will likely be overestimated. While an asset may have low development
costs, its purchase may lead to high maintenance or customer service costs in the
future.

While most short-term costs—and even depreciation—can be readily measured or

estimated, long-term costs are more difficult to estimate. In addition, factors such as
environmental or social impact cannot be easily quantified. Nevertheless, whole-life
costing may provide a more accurate picture of the true cost of an asset than most other
methods.

The value of determining whole-life cost can be demonstrated when considering the
purchase of a large piece of equipment for a factory. Consider for example a machine
that attaches nylon flock to foam rubber pads used in the construction of painting tools.
Beyond the initial cost of purchasing and installing the flocking machine, it will have any
number of components requiring periodic maintenance and replacement. Such a
machine may also present environmental hazards when cleaned or require complex
disassembly in order to be disposed of. The whole-life cost analysis of this equipment
purchase will be critical in estimating the long-term financial benefit of its purchase and
use.

KEY TAKEAWAYS

 Whole-life cost is the total expense of owning an asset over its entire life, from
purchase to disposal.
 Whole-life cost includes purchase and installation, design and building costs,
operating costs, maintenance, associated financing costs, depreciation, and
disposal costs.
 Whole-life cost also takes into account certain costs that are usually overlooked,
such as those related to environmental and social impact factors.
 Typically, the focus is on the up-front capital costs of creation or acquisition, and
many organizations fail to take into account the longer-term costs of an asset.

Discounting Factor

It is an economical reality that the value of our currency depreciates with time period
In case we are making financial decision based on future cash flows, it is very crucial to
consider the depreciated value and not the qualitative value.

Now the depreciated value of future cash flows in comparison of today is called as its
present value.

For the determination of present value, the future cash flows should be discounted
The rate of discounting is usually the inflation rate or the  cost of capital for the
company
What is the Discount Factor?
Discount Factor is a weighing factor that is most commonly used to find the present
value of future cash flows and is calculated by adding the discount rate to one which is
then raised to the negative power of a number of periods.
Discount Factor Formula
Mathematically, it is represented as below,
DF = (1 + (i/n) )-n*t
where,
i = Discount rate
t = Number of years
n = number of compounding periods of a discount rate per year

In the case of continuous compounding formula, the equation is modified as below,

DF = e-i*t
Calculation (Step by Step)
It can be calculated by using the following steps:
Step 1: Firstly, figure out the discount rate for a similar kind of investment based on
market information. The discount rate is the annualized rate of interest, and it is denoted
by ‘i.’
Step 2: Now, determine how long the money is going to remain invested, i.e., the tenure
of the investment in terms of several years. The number of years is denoted by ‘t.’
Step 3: Now, figure out the number of compounding periods of a discount rate per year.
The compounding can be quarterly, half-yearly, annually, etc. The number of
compounding periods of a discount rate per year is denoted by ‘n.’ (The step is not
required for continuous compounding)
Step 4: Finally, in the case of discrete compounding, it can be calculated using the
following formula as,
DF = (1 + (i/n) )-n*t
On the other hand, in the case of continuous compounding, it can be calculated using
the following formula as,
DF = e-i*t
Now you may ask what is discrete compounding and what is continous compounding
and what is their difference.

To clarify, Discrete compounding refers to the method by which interest is

calculated and added to the principal at certain set points in time. ... Discrete
compounding is the opposite of continuous compounding, which uses a
formula to compute interest as if it were being constantly calculated and
added to principal.
An example of the present value with continuous compounding formula would be an
entrepreneur who in four years would like to have P120,000.00 in an interest account
that is providing an 8% continuously compounded return. To solve for the current
amount needed in the account to achieve this balance in two years, the variables are
P120,000.00 is FV, 8% is r, and 2 years is t. The equation for this example would be

PV = FV/e^rt

PV  = P120,000/e^((.08)(4))

PV =

Key Takeaways
 Discount Factor is a weighing factor that is most commonly used to find the
present value of future cash flows.
 It is calculated by adding the discount rate to one which is then raised to the
negative power of a number of periods.
 Mathematically, it is represented as below,
 DF = (1 + (i/n) )-n*t
 In the case of continuous compounding formula, the equation is modified as
below,
DF = e-i*t

Capital Recovery
By 
ALEXANDRA TWIN
 
 
Updated Jan 17, 2020
What Is Capital Recovery?
Capital recovery is a term that has several related meanings in the world of business. It
is, primarily, the earning back of the initial funds put into an investment. When an
investment is first made in an asset or a company, the investor initially sees a negative
return, until the initial investment is recouped. The return of that initial investment is
known as capital recovery. Capital recovery must occur before a company can earn a
profit on its investment.

Capital recovery also happens when a company recoups the money it has invested in
machinery and equipment through asset disposition and liquidation. The concept of
capital recovery can be helpful to a business as it decides what fixed assets it should
purchase.

Separately, capital recovery can be a euphemism for debt collection. Capital recovery
companies obtain overdue payments from individuals and businesses that have not
paid their bills. Upon obtaining payment and remitting it to the company to which it is
owed, the capital recovery company earns a fee for its services.

Capital Recovery Explained

Capital recovery represents the return of your initially invested capital over the lifespan
of an investment. At the initial point of investment, it is impossible to determine what the
true return on the investment will be. That can't be determined until the investment is
returned to you, ideally, with a profit. "Capital Recovery" can be referenced both in
terms of long-term investments and with companies, divisions, or business lines.

A capital recovery analysis is typically done before a company makes a substantial new
purchase. Initial cost, salvage value and projected revenues factor into a capital
recovery analysis when a company is determining whether and at what cost to
purchase an asset or invest in a new project.

There are capital recovery companies that may specialize in collecting a particular type
of debt, such as commercial debt, retail debt or healthcare debt. If a company is going
out of business and needs to liquidate its assets or has excess equipment that it needs
to sell, it might hire a capital recovery company to appraise and auction off its assets.
The company can use the cash from the auction to pay its creditors or to meet its
ongoing capital requirements.

The Uses of Capital Recovery

When a company is thinking about purchasing a new asset or even a new business,
capital recovery is a helpful factor in that decision-making process.

Example: let's say your eCommerce company is considering purchasing a new robotics
system, similar to the one used by Amazon.com, that helps retrieve products from
storage faster, and therefore accelerate the shipping process and delivery to customers.
The new system costs $200,000 to purchase and has a potential salvage value of
$50,000, meaning the overall net cost will be $150,000. You estimate that you can
generate an extra $400,000 in revenues over the next five years as a result of the
robotics system. The $400,000 in revenues far surpasses the $150,000 in net costs
needed to make the purchase.

All things being equal, should your company make this choice, it would likely recover all
of its invested capital and ultimately make a higher profit because of the investment.

KEY TAKEAWAYS

 Capital recovery refers primarily to recovering initial funds put into an investment
through returns from that investment, making it a break-even measure.
 It can also refer to a recouping invested funds through the disposition of assets.
 The term can also refer to corporate debt collection.