Professional Documents
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LCCA Primer
LCCA Primer
Cost Analysis
Primer
Life-Cycle Cost Analysis Primer
August 2002
LCCA Issues 20
Agency Data Requirements 20
Uncertainty 21
User Costs 21
Conclusion 24
T
he Federal Highway Administration’s (FHWA’s) Office of Asset Management is
pleased to present this Life-Cycle Cost Analysis Primer. This Primer is intended
to provide sufficient background for transportation officials to investigate the
use of life-cycle cost analysis (LCCA) to evaluate alternative infrastructure investment
options. Additionally, the Primer demonstrates the value of such analysis in making
economically sound decisions.
LCCA is an engineering economic analysis tool useful in comparing the relative
transportation users and provides a means to balance those effects with the construc-
tion, rehabilitation, and preservation needs of the system itself.
LCCA’s value as a decision-support tool is contingent upon its proper use. While the
economic concepts that support this type of analysis are fairly straightforward, their
application presents a number of challenges. Frequently there are uncertainties as to
when and how LCCA should be employed and what assumptions should be made dur-
ing the course of the analysis. By carefully describing the LCCA methodology and
process and by addressing the uncertainties, this Primer is intended to encourage a
broader application of this important investment tool.
FHWA has pursued a policy of promoting LCCA for transportation investment de-
cisions since the Intermodal Surface Transportation Equity Act of 1991. Throughout
the 1990s FHWA investigated LCCA. In Fall 1996, FHWA initiated a technology
Technical Bulletin on LCCA, Life-Cycle Cost Analysis in Pavement Design. FHWA is cur-
rently developing instructional software and will continue to provide technical assistance
and training to assist individual transportation agencies as they explore the use of LCCA
Tommy L. Beatty
Acting Director, Office of Asset Management
L
ife-cycle cost analysis (LCCA) is an evaluation tech- LCCA is reasonably straightforward to understand and
nique applicable for the consideration of certain perform. It incorporates both the transportation agency’s
transportation investment decisions. Specifically, institutional knowledge and the application of sound eco-
when it has been decided that a project will be nomic analysis techniques.
implemented, LCCA will assist in determining the best— In brief, the LCCA process begins with the develop-
the lowest-cost—way to accomplish the project. ment of alternatives to accomplish the structural and per-
The LCCA approach enables the total cost compari- formance objectives for a project. The analyst then de-
son of competing design (or preservation) alternatives, fines the schedule of initial and future activities involved
each of which is appropriate for implementation of a trans- in implementing each project design alternative. Next,
portation project. All of the relevant costs that occur the costs of these activities are estimated. Best-practice
throughout the life of an alternative, not simply the origi- LCCA calls for including not only direct agency expen-
nal expenditures, are included. Also, the effects of the ditures (for example, construction or maintenance activi-
agency’s construction and maintenance activities on ties), but also costs to facility users that result from these
users, as well as the direct costs to the agency, are agency activities.
accounted for. The predicted schedule of activities and their associ-
ated agency and user costs form the projected life-cycle
cost (LCC) stream for each design alternative. Using an
A “project” is a transportation investment that ful- economic technique known as “discounting,” these costs
fills the agency’s requirements to provide a given are converted into present dollars and summed for each
level of performance to the public. A “project al- alternative. The analyst can then determine which alter-
ternative” is a proposed means to provide that per- native is the most cost-effective. A more thorough
formance. As the level of performance is defined description of the LCCA process is provided in the
by the project, and all alternatives meet the require- methodology section of this Primer.
ments of the project equally, the economic differ- It is important to note that the lowest LCC
ence between alternatives is dictated by total cost. option may not necessarily be implemented when
other considerations such as risk, available bud-
gets, and political and environmental concerns are
taken into account. LCCA provides critical infor-
mation to the overall decision-making process, but
not the final answer.
D
ecisions related to implementation of a trans- LIFE-CYCLE COSTS
portation improvement generally require that
The idea behind LCCA is that transportation investment
several alternatives be considered. Many factors
decisions should consider all of the costs incurred during
contribute to an agency’s decision to select a par-
the period over which the alternatives are being com-
ticular option, although initial project costs may domi-
pared. Transportation investments are required to pro-
nate this decision.
vide service for many years. The ability of a transporta-
Initial agency costs, however, tell only part of the story.
tion asset to provide service over time is predicated on its
The design alternative selected will commit the agency
being maintained appropriately by the agency. Thus the
to future expenditures for maintenance and rehabilita-
investment decision should consider not only the initial
tion actions over the life cycle of the project. Further-
activity that creates a public good, but also all future
more, the selected alternative will accrue costs to facility
activities that will be required to keep that investment
users through project activities that directly impact the
available to the public. Those future activities are part of
traveling public.
the alternative as much as the initial action is; without
LCCA provides the means to include total cost to both
periodic maintenance and rehabilitation, the investment
the agency and the user in the investment decision. Ad-
will not provide continued use to the public.
ditionally, the structure and documentation of the LCCA
Specific future rehabilitation and maintenance activi-
process provide the transportation agency with the abil-
ties are in large part dictated by the design alternative
ity to enhance its stewardship of the public’s investment.
selected. For example, a steel girder bridge will require
Documentation is also a resource that the agency can use
periodic painting whereas a concrete girder bridge will
in educating newer employees and maintaining the
not. However, a concrete bridge might not have the span
agency’s institutional knowledge.
lengths that a steel bridge can have and may
require construction of an additional col-
umn pier, with the additional construction
and maintenance costs that it would engen-
der. Future costs should be considered as
relevant as initial costs to the investment
decision.
USER COSTS
As transportation agencies are increasingly
viewed as providers of mobility to the pub-
lic, travel time, vehicle costs, and safety
impacts become more important to invest-
ment decisions. Though these user costs are
not directly borne by the agency, they af-
fect the agency’s customers and the custom-
ers’ perceptions of the agency’s perfor-
mance.
PRESERVATION
Preservation is a rapidly emerging concept in transpor-
tation. LCCA provides a method to evaluate the effects
of preservation strategies. Preservation activities are dif-
ferent from traditional maintenance and rehabilitation In the face of increasing public sophistication and
activities: while traditional activities address existing de- interest, transportation agency officials are expected to
ficiencies in transportation assets, many preservation ac- explain and justify decisions concerning the expenditure
tivities are performed before deficiencies are visible or of taxpayer dollars. Documentation associated with the
even detectable. By applying specific treatments before LCCA process is a mechanism for transportation offi-
distress occurs, preservation activities delay the onset of cials to demonstrate their good stewardship of the public’s
deterioration and increase the useful lives of infrastruc- transportation infrastructure investment. Decision-
ture investments, thereby reducing agency expenditures makers have a record of their consideration of different
and lowering costs to users. assumptions and a formal analysis that supports the deci-
While preservation technologies offer the promise of sion itself. These records are available to be revisited dur-
extended service life, they themselves are not without cost. ing or after the LCCA process.
LCCA provides a means to judge the economic effec- LCCA documentation also serves to preserve the
tiveness of these activities through their effects on total public’s investment in transportation expertise. Transpor-
life-cycle costs. The investment’s reduced need for reha- tation agencies regularly lose sources of information and
bilitation and other maintenance is weighed against the expertise when personnel retire or move to other positions.
costs of the preservation treatments themselves. The de- The structure and documentation associated with the
bate over the value of preservation then moves from a LCCA process provide a means to preserve institutional
qualitative discussion to a fact-based exercise. knowledge. This information is then available for expe-
rienced decision-makers and new employees to consult.
STEWARDSHIP
CONCLUSION
Transportation officials strive to maximize the service of
mobility to the public while minimizing agency and LCCA provides a means for transportation decision-
user costs. LCCA enables decision-makers to find the makers to extend consideration of the merits of alterna-
least-total-cost alternative while still satisfying the re- tive projects beyond initial agency costs to include future
quirements of the investment. This allows money avail- agency and user costs. Additionally, LCCA documentation,
able for a given project to be spent in a fashion that as well as the analysis itself, can be used to demonstrate
produces the best long-term result, or the greatest “bang management’s commitment to good stewardship and to
for the buck.” making the analytical process more transparent and efficient.
O
nce a decision has been made to undertake a STEP ONE: ESTABLISH DESIGN ALTERNATIVES
project, LCCA provides a comprehensive
The LCCA process is initiated after an asset has been se-
means to select among two or more alterna-
lected for improvement and a range of possible alternatives
tives to accomplish the project. For LCCA to
has been identified for accomplishing that improvement. At
yield valid results, each project alternative considered
least two mutually exclusive options must be considered,
must provide the same level of service or utility for a spe-
and the economic difference between alternatives is assumed
cific, given volume of traffic. In the event that the
to be attributable to the total cost of each.
alternatives yield different levels of service or utility, then
benefit-cost analysis (BCA), not LCCA, would be the
appropriate decision tool. For example, the LCCA tech-
nique is not appropriate for contrasting competing ANALYSIS PERIOD
projects where one project would add additional roadway
lanes and another would rehabilitate existing pavements. Transportation assets are constructed to provide
For transportation agencies, the use of LCCA allows service for generations. Competing design alter-
different project alternatives to be compared not only natives may each have a different service life,
when the initial costs differ, but when costs following the which is the time period that the asset will re-
initial expenditure are expected to occur at different times main open for public use. Life-cycle cost analy-
and for varying amounts. sis (LCCA), however, uses a common period
The LCCA process steps are listed below. The steps of time to assess cost differences between these
are ordered so that the analysis builds upon information alternatives so that the results can be fairly com-
gathered in prior steps. pared. This time period is termed the “analysis
period.” Allowing analysis periods to vary among
1. Establish design alternatives design alternatives would result in the compari-
2. Determine activity timing son of alternatives with different total benefit
3. Estimate costs (agency and user) levels, which is not appropriate under LCCA.
4. Compute life-cycle costs The analysis period should demonstrate the
5. Analyze the results total cost differences between the alternatives.
Accordingly, the analysis period should be long
The LCCA approaches and techniques outlined in this enough to include the initial construction or
section are consistent with FHWA’s LCCA Interim Tech- major rehabilitation action and at least one sub-
nical Bulletin, Life-Cycle Cost Analysis in Pavement Design, sequent rehabilitation action for each alternative.
which was published in 1998. The Interim Technical However, each alternative does not need to have
Bulletin provides a more detailed discussion of this meth- the same number of maintenance or rehabilita-
odology and its components, particularly with regard to tion activities during the analysis period.
user cost calculations and the treatment of uncertainty in
an analysis.
Time
Service Life: Service Life: Service Life:
Initial Construction Rehabilitation One Rehabilitation Two
In the first LCCA step, component activities for each funds will be expended, and when and for how long the
alternative are detailed and the analysis period is defined. agency will establish work zones.
Each alternative is defined by the agency activities that When first constructed or substantially rehabilitated,
create and maintain it. Initial construction or a major re- transportation assets are in good condition and provide
habilitation of an asset is only the first of these activities; service as originally intended. Use, age, weather, and other
periodic maintenance and subsequent rehabilitation are factors cause assets to deteriorate, and deterioration causes
required for the alternative to provide a specified level of the level of performance provided by the asset to fall. Pe-
performance throughout its life. Different project alter- riodic maintenance and rehabilitation activities will ar-
natives will likely require different maintenance and re- rest deterioration and improve the asset’s condition so as
habilitation activities. Typically, the identification of main- to maintain sufficient levels of condition, performance,
tenance and rehabilitation activities is based on historical and safety. Each agency decides when to perform these
practice, research, and agency policies. activities, usually based on the desired level of service-
Important in this first step is defining the analysis pe- ability.
riod, the common timeframe for which initial and future Figure 1 demonstrates the cycle of construction, dete-
costs will be evaluated for all alternatives being consid- rioration, and rehabilitation that a typical transportation
ered. In general, the analysis period should be long asset undergoes. As the asset’s condition nears the agency’s
enough to include at least one major rehabilitation activ- minimum acceptable condition, rehabilitation activities
ity for each alternative being considered. are conducted. The rate of deterioration, as influenced
by pavement preservation practices, dictates the timing
of future activities. Initial activities occur in the begin-
STEP TWO: DETERMINE ACTIVITY TIMING
ning of the analysis period, and future activities are shown
After the component activities for each competing project in the years they are anticipated.
alternative have been identified, each alternative’s main- LCCA requires that the series of maintenance and re-
tenance and rehabilitation plan is developed. Effectively, habilitation activities forecasted for each improvement
this plan results in a schedule of when the future mainte- strategy be as accurate as possible because the expenses
nance and rehabilitation activities will occur, when agency associated with these activities can account for a sizeable
REMAINING SERVICE LIFE VALUE In previous steps, the alternatives were defined with re-
spect to agency costs, user costs, and the time when these
Design alternatives should be evaluated over events will occur. At this point, the objective is to calcu-
equivalent analysis periods in order to yield fair late the total LCCs for each alternative so that they may
comparisons of life-cycle costs. However, in many be directly compared. However, because dollars spent at
cases, one or more alternatives will have service different times have different present values, the projected
lives that exceed the analysis period. Any service activity costs for an alternative cannot simply be added
life exceeding the analysis period is known as re- together to calculate total LCC for that alternative. Eco-
maining service life (RSL). Failure to account for nomic methods are available to convert anticipated fu-
differing RSLs can result in an economic bias to- ture costs to present dollar values so that the lifetime costs
ward one or another alternative when using life- of different alternatives can be directly compared.
cycle cost analysis. The Federal Highway
Administration’s Interim Technical Bulletin rec- Expenditure Stream Diagrams
ommends a means to value RSLs based on project
To assist the analyst in visualizing the quantity and tim-
cost and the percentage of design life remaining
ing of expenditures projected over the life of the analysis
at the end of the analysis period.
period, expenditure stream diagrams may be developed.
RSL value is different from salvage value. RSL
An expenditure diagram (see Figure 2) depicts a design
value exists only if the alternative will continue in
alternative’s (1) initial and future activities; (2) agency and
operation after the end of the analysis period,
user costs associated with these activities; and (3) the tim-
whereas salvage value requires termination. Sal-
ing of these activities and costs. Upward arrows on the
vage value is obtained only when some actual value
diagram are expenditures with the relative costs reflected
is realized from the sale or reuse of scrap materi-
in the length of each arrow. The horizontal arrow seg-
als. When applied at the end of the analysis pe-
ments show the timing of the work zone activities and
riod, RSL value and salvage value can generally
the periods of normal operations between them. The RSL
be considered mutually exclusive.
value (or the salvage value, if the asset is to be termi-
End of
Initial First Second Analysis
Construction Rehabilitation Rehabilitation Period
Estimated Activity Costs
User Costs
Ti T1 T2 Agency Costs
Remaining
Service
Estimated Agency Timing User Costs
Life Values
Inflation indexes are available for every possible product and service. The choice among indexes from
broad (e.g., Gross Domestic Product chain deflator) to intermediate (e.g., a consumption index such as the
Consumer Price Index) to narrow sector or commodity (e.g., highway construction or resurfacing costs)
depends upon how the results are to be interpreted.
Real discount rates used in life-cycle cost analysis typically range from 3 to 5 percent, representing the
prevailing rate of interest on borrowed funds, less inflation. Because there is always an opportunity value of
time, real discount rates will always exceed zero. Through the use of a real discount rate, the following
transformations can be performed to facilitate comparison of the constant dollar costs of alternative trans-
portation projects:
• Relocation in Time. A single figure can be “moved” (transformed into an equivalent value) backward or
forward in time, without altering its real value, i.e., its present worth.
• Annualized Cost. A lump sum can be transformed into an equivalent multiyear flow (e.g., annualizing a
capital cost).
• Present Value. Any combination of flows (finite or infinite) and lump sums can be summed into a single
value at a single point in time.
continued
likelihood that a selected input value will actually occur. From the perspective of most transportation agencies, the
Therefore, while a deterministic LCCA approach pro- application of probabilistic LCCA is relatively new.
vides considerably more information about the economic Probabilistic LCCA has been made more practical due
reasonableness of a project than just its initial cost, it does to the dramatic increases in computer processing capa-
not offer decision-makers a complete picture of the ex- bilities of the last two decades. Simulating and account-
pected PVs. ing for simultaneous changes in LCCA input parameters
may now be accomplished easily and quickly.
Probabilistic Approach. With deterministic LCCA, dis-
crete values are assigned to individual parameters. In con-
STEP FIVE: ANALYZE THE RESULTS
trast, probabilistic LCCA allows the value of individual
analysis inputs to be defined by a frequency (probability) Step five involves analyzing and interpreting the LCCA
distribution. For a given project alternative, the uncer- results. With the deterministic or probabilistic LCCs
tain input parameters are identified. Then, for each un- computed, the PVs of the differential costs may be com-
certain parameter, a sampling distribution of possible val- pared across competing alternatives. Because the deter-
ues is developed. Simulation programming randomly ministic approach results in a single PV for each alterna-
draws values from the probabilistic description of each tive and the probabilistic approach yields a distribution
input variable and uses these values to compute a single of PV results, the procedures used to analyze the results
forecasted PV output value. This sampling process is are different.
repeated through thousands of iterations. From this it- Although best-practice LCCA considers both agency
erative process, an entire probability distribution of PVs and user costs, in actual practice many analysts are reluc-
is generated for the project alternative along with the tant to assign the same level of validity to user costs that
mean or average PV for that alternative. The resulting they assign to agency costs. Thus, alternatives are often
PV distribution can then be compared with the projected compared chiefly on agency costs. User costs may be com-
PVs for alternatives, and the most economical option for pared to see if an alternative has a disproportionately high
implementing the project may be determined for any or low impact on users compared to other alternatives. If
given risk level. the lowest-agency-cost alternative also has a dispropor-
Probabilistic LCCA accounts for uncertainty and tionately high user-cost impact, the analyst may use this
variation in individual input parameters. It also allows information to revisit that alternative to mitigate user
for the simultaneous computation of differing assump- costs, or may recommend that an alternative with some-
tions for many different variables. It conveys the likeli- what higher agency costs but much lower user costs be pur-
hood that a particular LCC forecast will actually occur. sued in preference to the lowest-agency-cost alternative.
Alternative A Alternative B
Discounted Discounted Discounted Discounted
Year Discount Factor Agency Costs User Costs Agency Costs User Costs
0 1.0000 $26,000,000 $11,000,000 $20,000,000 $8,000,000
12 0.6246 3,747,582 6,245,970
20 0.4564 6,845,804 13,691,608 2,738,322 7,302,191
28 0.3335 2,000,865 9,337,369
35 0.2534 (950,308) (1,900,616) (190,062) (886,954)
Total Costs (PV) 31,895,496 22,790,992 28,296,707 29,998,576
L
CCA provides a methodology for comprehensive AGENCY DATA REQUIREMENTS
analysis of an investment decision. It is reason-
LCCA is data-intensive, and its value, as with any quantita-
ably easy to understand and perform, and its out-
tive analysis technique, depends on the quality of the input
puts are useful to decision-makers. However, it has
data. Transportation agencies have been collecting data for
yet to become a routine analysis tool in transportation
years on their asset inventory and its condition. However,
project decision-making. This is due in part to a lack of
the inputs that LCCA requires (e.g., long-term maintenance
understanding of its usefulness in support of investment
data) are often not directly available from agency informa-
decisions. It is also due to the belief that there are im-
tion systems and must be derived from multiple data sources.
pediments to the proper use of LCCA. This section will
Unless an agency’s data collection and storage have been
discuss some of the issues that might be faced by trans-
specifically designed to support LCCA, it is unlikely that
portation agencies that choose to incorporate LCCA into
existing data sources will fit the exact needs of LCCA with-
their investment decision process.
out further work.
The technological revolution of the
last two decades has enabled many au-
tomated transportation data manage-
ment systems. States that have in-
vested in these systems, whether
project information systems or bridge
or pavement management systems,
often have access to agency cost and
service life data. Transportation agen-
cies may find that developing inputs
for LCCA is not a matter of finding
enough input data but rather what to
do with the myriad of possible values
that present themselves.
Historical agency data are only one
mechanism that may be used to feed
LCCA input needs. The expert opin-
ion of senior agency staff members can
also provide a wealth of information
for investment analyses, as can
USER COSTS
User costs may represent the greatest data challenge to
LCCA implementation. When calculated, user costs are
often so large that they may substantially exceed agency
costs, particularly for transportation investments being
considered for high-traffic areas.
S
ince the early 1990s, FHWA has pursued a policy Within FHWA, the Office of Asset Management is
of encouraging the use of LCCA for certain trans- charged with developing and improving the state of the
portation investment decisions. The LCCA pro- art for LCCA tools. Most recently, the Office undertook
gram is one of a number of initiatives being development of an LCCA probabilistic software package
advanced under the broad engineering economic analy- and workshop. This software is instructional in orienta-
sis (EEA) umbrella. FHWA’s long-term goal is to fill an tion and has been designed to follow the LCCA method-
EEA “toolbox” with a variety of applications useful for ology as outlined in the Interim Technical Bulletin. The
project- or program-level evaluations. new workshop will promote exploration of the use of
LCCA in the project design decision process. The work-
shop and software will support agencies as they perform
FHWA ACTIVITIES
LCCA on pavement projects and will allow managers and
In 1993, FHWA and the American Association of State their agencies to investigate the full range of effects on
Highway and Transportation Officials jointly sponsored
an LCCA symposium of senior transportation officials
from FHWA and State transportation agencies. The sym-
posium highlighted the need for total cost analysis in
transportation decision-making and elevated the aware-
ness of decision-makers about LCCA.
In 1998, FHWA published the LCCA Interim Tech-
nical Bulletin. In addition to detailing the LCCA mecha-
nism, it describes how to derive user work zone delay
costs through basic traffic information and addresses the
uses of probability and risk analysis in LCCA. FHWA
also produced Demonstration Project 115, which includes
an instructional workshop based on the Interim Techni-
cal Bulletin. FHWA Resource Center personnel provide
the workshop as well as support services in the applica-
tion of LCCA.
Also in 1998, the Transportation Equity Act for the
21st Century was enacted. It required that a value engi-
neering review be performed for any project greater than
$25 million that has Federal involvement. A value engi-
neering review looks at such things as constructability,
design criteria, and cost estimates. FHWA recommends
that LCCA be a part of value engineering reviews.
T
he FHWA encourages the use of LCCA for certain transportation investment
decisions. LCCA is an important analytical tool that is applicable to a broad
range of routine decisions facing State and local transportation agencies. It is
appropriately applied once a decision has been made to undertake a project or im-
provement but the specific design for accomplishing the project’s objectives has not
been chosen.
rehabilitation and maintenance activities. Best-practice LCCA also directs the analyst
to quantify and compare the effects of different project implementation options on
highway users, who may experience significant costs due to congestion and safety issues
associated with work zones.
sign decision in the event of future controversy. More importantly, the documentation
helps to preserve important agency knowledge so that it may inform future analysts and
decision-makers.
Implementation of LCCA for project evaluation may require education of staff and
adjustments in the agency decision-making process. However, it clearly presents trans-
portation agencies with a means of identifying the most cost-effective investment op-
tions. LCCA is an important tool, and one that may lead to the broader application of
more comprehensive EEA tools. FHWA will continue to promote LCCA applications
through its training efforts and the development and distribution of LCCA software.
Telephone: 202-366-9242
Fax: 202-366-9981
FHWA IF-02-047