LIFE CYCLE COST ANALYSIS REVISITED

Mark B. Snyder, Ph.D., P.E.

Engineering Consultant, Bridgeville, Pennsylvania, USA

ABSTRACT

Life cycle cost analysis is a process for evaluating the total economic worth of competing
project alternatives by analyzing initial costs and discounted future costs and benefits over
the expected life of the project. Key inputs to the process include the magnitude and timing
of costs (and benefits), the determination of an appropriate discount rate, and the
estimation and use of “user costs”. Of lesser (but still potentially significant) importance are
the uses of “salvage value” and “remaining service life value.”

This paper discusses current “best practices” for life cycle costs analyses with regard to
the selection and use of each of these inputs and considers the sensitivity of the analysis
to each. Particular attention is given to the determination of appropriate sector-specific
discount rates, i.e., whether different segments of the economy, such as public sector
heavy construction, which includes most highway pavement and airfield construction,
should use discount rates other than those determined by government-issued financial
instruments and overall rates of inflation.

The concept of probabilistic life cycle cost analysis (as opposed to traditional deterministic
analysis) is also briefly discussed.

1. OVERVIEW OF LIFE CYCLE COST ANALYSIS

For the purposes of highway and airfield applications, life cycle cost analysis (LCCA) can
be defined as “a process for evaluating the total economic worth of a usable project
segment by analyzing initial costs and discounted future costs, such as maintenance, user,
reconstruction, rehabilitation, restoration and resurfacing costs over the life of the project
segment.” (Source: U.S. Transportation Equity Act for the 21st Century)

LCCA is a tool that is commonly used to assist decision-makers in selecting from

competing alternative strategies or designs the alternative(s) that appear to be the most
economical over a given analysis period when considering all costs and benefits that can
be quantified monetarily. The evaluation of alternative options over both monetary and
nonmonetary decision criteria simultaneously cannot be done using LCCA alone and
requires the application of so-called “value engineering” techniques, which are not
discussed herein.

LCCA can be described as a five-step process:

1. Identify feasible alternatives. Pavement LCCA are greatly simplified and more easily
validated if the alternatives provide equal benefits (i.e., the same levels of service)
over the analysis period.
2. Determine the activities (resulting in expenses) and the timing of these activities for
each feasible alternative (i.e., what maintenance and rehabilitation activities are

Proceedings of the International Conference on Concrete Roads (ICCR2007) 16 – 17 August 2007

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43
 expected and when will they take place).
3. Estimate the costs for each activity in each feasible alternative. These costs should
include both agency costs and user costs (e.g., vehicle delay and accident costs).
Costs that are the same (both value and timing) for all alternatives can be eliminated
from the analysis.
4. Compute the life cycle costs using one of many different analysis techniques,
including “net present worth or cost”, “equivalent annual worth or cost”, “(incremental)
benefit/cost ratio” or “(incremental) rate of return.” Each of these techniques, when
applied properly, will rank various alternatives in the same order of economic
preference. However, the first two techniques are generally easiest to apply (i.e.,
most difficult to do incorrectly!) and are generally preferred for pavement type and
rehabilitation selection analyses.
5. Analyze the results and consider how agency costs and user costs compare among
the various alternatives.

The analyses described in step 4 above all require the selection of various economic
inputs, including:

1. a “discount rate” that represents the combined effects of changes in the time value of
money (i.e., inflation) and the cost of money (i.e., interest or opportunity cost);
2. an analysis period (generally recommended for pavement applications to be long
enough to include at least one rehabilitation activity);
3. expected maintenance and rehabilitation activities (including their expected timing
and costs to both the agency and the users); and
4. salvage value and “residual” or “remaining service life” value.

This paper discusses considerations for selecting some of these inputs and for performing
the LCCA.

2. IDENTIFYING EQUIVALENT ALTERNATIVES

LCCA is appropriately applied only to “equivalent alternatives,” which (for pavements) are
defined as alternatives that provide the same levels of service and benefits to the user at
any specified volume of traffic. “Equivalent alternatives” do not necessarily have the same
design life or the same structural capacity. They are capable, however, of providing similar
levels of capacity for traffic loads and volumes while providing reasonably similar levels of
serviceability throughout the life of the structure.

3. SELECTING AN APPROPRIATE DISCOUNT RATE

3.1 Importance of the Discount Rate

When properly selected and applied, the “discount rate” is the factor that allows economic
analysts to use constant (i.e., todays) monetary values at all points in time in the LCCA.
The results of LCCA are very sensitive to the selection of the discount rate because higher
values reduce the present value of future costs (and benefits), resulting in more favorable
economic consideration of alternatives with lower initial costs and higher maintenance and
rehabilitation costs. Conversely, lower discount rates treat future costs as being nearly
equal in value to initial costs, resulting in more favorable consideration of alternatives with
fewer maintenance and rehabilitation costs, even if they have somewhat higher initial
costs.

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3.2 Discount Rate Defined
The discount rate used in most LCCA is sometimes called the “real discount rate” and can
be defined as follows:

“Nominal” Discount Rate – Inflation Rate

“Real” Discount Rate =
1 + Inflation Rate
where:

“Nominal” Discount Rate = the cost of funds (interest rate) or the potential return
on an investment forgone; and
Inflation Rate = the rate of future increases in costs due to the erosion of
monetary value.

It is worth noting that this equation suggests that it is the difference between “interest” and
“inflation” that is most relevant and that the absolute values of these two parameters are
relatively unimportant!

3.3 Discount Rate – Consideration of the Traditional Public Sector View

The traditional public sector view of the discount rate is that it should reflect “social
opportunity costs.” In other words, the “interest” part of the equation should represent the
potential return (i.e., additional benefits to the public) that would have been realized by
spending the funds in a different sector of the economy (e.g., on public schools or social
programs or other budget items). It is very difficult to quantify the relative values of
investing in one area of the public sector versus any other, so most public sector
economists use a generalized discount rate that is based on the returns provided by
government bonds (e.g., Treasury Bill yields) and forecast overall inflation. In the U.S.,
these figures generally result in the use of a discount rate of between 3.0 and 4.0 percent,
depending upon the length of the selected analysis period.

Possible fallacies in this view include the following:

• Government agencies typically invest very little (if any) money at prevailing interest
rates; budgets are typically spent during the budget cycle and accrue no long-term
interest.
• Most highway funds come from taxes and tolls with some funding from the sale of
bonds. The cost of money to public sector agencies is typically very low.
• In many instances, highway funds are “dedicated” and savings produced by selecting
one design or rehabilitation alternative over another cannot be used for other purposes
such as education, social programs, etc. Therefore, there is no “cost of opportunity
forgone.”

Therefore, for many highway agencies, “nominal discount” or “interest” rates approach
zero.

Furthermore, the rate of inflation for the goods and services required to design, construct
and maintain pavements may be significantly different from the official government rate of
inflation for consumers. For example, in recent years, the U.S. Consumer Price Index
(which measures the prices that consumers pay for a “fixed basket” of goods and is the
most common measure of inflation in the U.S.) rose by about 1.6 – 3.4 percent per year
between 2001 and 2006 and is up by 3.1 percent in the first 5 months of 2007 (U.S.
Bureau of Labor Statistics, 2007). By contrast, the U.S. Government Industry Producer

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Price Indexes for Highway and Street Construction was relatively flat from 2001 through
2003, but increased by 8.5%, 12.6% and 10.8% in 2004, 2005 and 2006, respectively, and
is up by 7.1% in the first 6 months of 2007 (annual rate of increase of 14.2%) (U.S. Bureau
of Labor Statistics, 2007a).

It is clear that, for highway agencies, the use of a discount rate that is based on market
interest rates and the rate of inflation of a standard consumer shopping basket is
inappropriate for economic analyses in the highway and heavy construction industries.
Furthermore, the use of “standard” general discount rates may lead to the selection of a
construction or rehabilitation alternative that is not the most cost-effective (and may even
be the least cost-effective).

3.4 Selecting an Appropriate Discount Rate

The most accurate economic analysis results will be obtained using a discount rate that
reflects the actual cost of funds to the agency (e.g., the average rate of return on portions
of the income stream that are invested, or the weighted average cost of money when
bonding is used for funding) and the actual rate of inflation for the appropriate segement of
the economy (and the appropriate geographic region of the country).

Example: A particular highway agency has an annual budget of approximately $10 million,
of which $8 million is derived from dedicated user fees and $2 million is obtained through a
bonding program (bonds yield 5 percent annually). The debt service on these bonds is
$100,000 per year, so the weighted average agency-specific interest rate in this case is
$100,000/$10,000,000 is 1.0% per year.

Assuming that average highway and heavy construction inflation over the analysis period
(say, 30 years) matches the consumer price index, it may average about 3.5 percent. The
appropriate discount rate in this case would be (0.01 – 0.035)/1.01 = -0.0248 or -2.48
percent! Using a higher rate of inflation for the highway and heavy construction industry
(one that reflects the rates observed over the last several years) would produce an even
more negative value for the discount rate.

A negative discount rate would weight the value of future expenditures more heavily than
the value of present expenditures. This concept may seem foreign, but it may be most
appropriate, especially in an economic environment where the cost of money is low (or
zero).

4. SALVAGE AND REMAINING SERVICE LIFE (RESIDUAL) VALUES

Salvage and remaining service life (residual) values are often mistaken for representing
the same considerations, but they are quite different!

4.1 Salvage Value

Salvage value is the value of in-place paving materials at the end of the pavement service
life (e.g., the value of old Portland cement concrete as a source of recycled aggregate or
as a foundation for a new pavement structure). Both concrete and asphalt pavements are
completely recyclable and have salvage value. While salvage value is generally
considered to be a benefit or credit at the end of the pavement life, it may be a negative
value (cost) if the costs of removal and/or disposal exceed the value of the material.

Since salvage value occurs at the end of the service period, which may approach or
exceed 40 years for concrete pavements, it has often been considered to be negligible in
the context of positive discount rates (especially high discount rates). However, salvage

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value can be quite significant when the selected discount rate is relatively low (e.g., less
than 2 percent) or negative.

An additional consideration for including (or ignoring) salvage value in LCCA is that the
existing structure can be considered as part of the in situ condition for reconstruction, in
which case the cost (or benefit) of disposal (or recycling) will be reflected in estimates and
bids for the new pavement structure. In such cases, the inclusion of salvage values as a
benefit at the end of the analysis period and as a reduction in cost at the beginning of the
analysis period is “double counting” the value of the old material. Salvage values should
not be used in LCCA in such cases; the reduction in initial cost is known with reasonable
certainty and should be used in lieu of an estimate of the value of the aged material at the
end of the pavement service life.

4.2 Remaining Service Life (Residual) Value

Net Present Worth/Cost (NPW/C), Benefit/Cost (B/C) and Rate of Return (ROR) analyses
require that all alternatives being considered have equal analysis periods. Therefore, if
either of these approaches is used (and NPW/C is generally preferred because of its
relative simplicity), the either:

a) all alternatives considered must have the same design lives (initial service period
plus one or more rehabilitation service periods), or
b) longer-lived alternatives must be artificially shortened and have a credit provided for
the value of the unused Remaining Service Life.

Equivalent Uniform Annual Worth/Cost analyses avoid the use of residual values by
implicitly assuming that each alternative design or rehab strategy will be repeated (with the
same cash flow stream).

There are many approaches to developing an estimate of the remaining service life value
for any given pavement design or rehabilitation alternative. The most widely used
approach is to take a linear depreciation of the cost of the last rehabilitation with respect to
the expected life of the rehabilitation, as shown in figure 1. Note that the depreciated value
of the last rehabilitation activity is determined and shown as a benefit at the end of the
pavement service life.

Figure 1. Illustration of determination of remaining service life (residual) value

(graphic courtesy of ACPA, FHWA).

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5. CONSIDERATION OF USER COSTS

“User costs” are typically considered to represent the impact on the traveling public and
commercial entities of various roadway maintenance activities and levels of service. They
may include:

• the costs of travel delays and detours (both added time and distance) due to
construction (initial construction, maintenance activities and rehabilitation work),
• the costs of increased fuel consumption with increased levels of road roughness,
• the costs of increased vehicle wear and maintenance with increased levels of road
roughness,
• the direct and social costs of accidents, including property damage, injuries and
fatalities,
• motor fuel taxes and tolls, and
• many, many more.

There are many tools and models for estimating the value of user costs. The recently
released FHWA RealCost 2.2 program is among the more widely implemented programs
for performing LCCA that includes a reasonably detailed but implementable user cost
estimation component. It includes simulation of many scenarios, including closures during
specific time frames (e.g., weekdays, weekends, nights) and allows the comparison of user
costs for multiple alternatives using a Visual Basic-enhanced Excel spreadsheet. This
program and the associated user’s manual can be downloaded at no charge from the
FHWA website (FHWA, 2006).

It is clear that user costs are quite real, highly significant and are a valid consideration in
the decision-making process. There remains, however, considerable debate over how they
should be computed and included in the process.

There are several valid arguments against including user costs on an equal basis and in
the same analysis as agency costs:

• Highway users have different (and varying) personal discount rates from those of
typical highway agencies (i.e., their costs of money and opportunity foregone are
different from those of highway agencies, as are the rates of inflation of their personal
market baskets). Therefore, user costs should be evaluated in a separate LCCA using
an appropriate and representative discount rate (typically a more standard general rate
in the range of 3 to 4 percent).
• Depending upon the components considered and how they are computed, user costs
can completely swamp agency costs in an economic analysis. A recent calculation of
user costs over the 30-year analysis period for a 6-lane facility carrying 110,000
vehicles per day totaled $12 billion, which was more than 25 times the projected
agency cost for constructing the project.
• Highway agencies are primarily responsible for managing their budgets in a manner
that optimizes the performance of the overall network at the highest possible level for
any given level of agency funding. It follows that the achievement of this goal also
generally serves to reduce user costs over the network as a whole and that their direct
inclusion in the agency economic analysis is unnecessary (and probably undesirable,
given the uncertainty in their value and the potential magnitude of their impact).

It is important to remember that many factors (both monetary and nonmonetary) are
considered (either formally or informally) in the process of selecting a specific design or
rehabilitation alternative from among competing alternatives and that agency costs (both

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initial and LCCA) and user costs are just two of the categories often considered. Other
factors may include availability of local materials, experience with specific designs or
construction techniques, political considerations, environmental impact and conservation of
resources (including potential for recycling), and many more.

There are many ways to consider all of the important monetary and nonmonetary decision
criteria. One popular approach based on utility theory is presented in some transportation-
related value engineering training workshops (NHI, 1999) and illustrated in figure 2. In this
approach, the important decision criteria are identified and are assigned relative weights
and each candidate alternative is rated (typically by a panel that represents designers,
maintenance engineers, users and administrators) with respect to each criterion. The
scores are then added for each alternative and those with the highest scores (Alternatives
A and D in figure 2, for example) are considered to be the best choices given the decision
criteria and weighting factors.

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Tra
Fut ptions
nse als
Ma

ffic

Tot
O
Use

ure
rva

al S
Co

Ran
tion
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Reh

ntro

cor
LC

kin
ost

of

ab
Decision Criteria:

e
l
s
C

g
Weighting Factor (%): 60 15 5 10 10 100
Alternative A 90 25 80 50 80 74.75 1
Alternative B 40 75 50 80 25 48.25 4
Alternative C 50 80 70 70 40 56.5 3
Alternative D 75 50 25 60 70 66.75 2
Figure 2. Example use of utility theory for considering several monetary and
nonmonetary decision criteria in evaluating competing pavement design or
rehabilitation alternatives.

6. PROBABILISTIC LIFE CYCLE COST ANALYSIS

Most LCCA are conducted using fixed assumptions concerning the timing of activities, the
magnitudes of initial and future costs, and the value of the discount rate. In reality,
however, none of these items is known with certainty; all of them are subject to a
probability distribution that is close to “normal” or bell-shaped, resulting in a “normal” or
bell-shaped distribution of net present value or cost for the expected cash flow stream
(Figure 3).

The consideration of these variables in LCCA is accomplished through probabilistic LCCA

(as opposed to deterministic LCCA, which is the term for performing economic analyses
using fixed values for all costs, activity times and discount rate values). Probabilistic LCCA
is currently considered the “state-of-the-art” in economic analysis for highway pavements
and is slowly gaining acceptance in implementation.

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 NPV = Initial Cost +
1
Future Cost x (1 + i)n

Figure 3. Illustration of the impact of variability in initial cost, future costs, discount
rate and rehabilitation timing on net present value (graphic courtesy of American
Concrete Pavement Association).

Among the primary benefits of probabilistic LCCA is the ability to evaluate expected levels
of life cycle cost for any given level of reliability or risk, which can result in the selection of
different alternatives at different levels of reliability/risk. This is illustrated in figure 4, which
shows that, for a particular evaluation, alternative A might be selected at the 50 percent
level because the expected cost is $22 million or less (versus $23 million or less for
alternative B). At the 90 percent level, however, alternative B might be chosen over A
because the expected cost at this level is less than that of A.

Figure 4. Example project cost distributions for competing alternatives, derived

using probabilistic LCCA (graphic courtesy of American Concrete Pavement
Association).

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Additional information and guidance on probabilistic LCCA is available from many
resources, including the U.S. Federal Highway Administration (FHWA, 2006).

7. SOME FINAL THOUGHTS ON LCCA

Initial costs one of the most influential factors in LCCA. In economic analyses of various
highway design or rehabilitation alternatives, initial costs typically account for between 65
and 90 percent of life cycle costs. The inclusion of various design features (e.g., high-
performance mixtures, stainless steel or alloy-clad dowel bars, deep foundation layers,
drainage systems, etc.) can add significantly to initial costs. It is essential that the analysis
reflect not only the costs of these enhancements, but also the expected improvements in
performance that go with them.

Discount rate is also highly influential in determining the results of the LCCA because of its
effect on the relative impact of deferred costs (such as maintenance and rehabilitation and
long-term user costs). It is essential that, in managing the assets of the highway agency,
the agency use a discount rate that accurately reflects its cost of money (typically very low)
and the rate of inflation of the items typically purchased with that money (currently very
high). The resulting discount rate may be very low or even negative.

The timing of selected maintenance and rehabilitation activities is the most important factor
after determination of initial costs and selection of the discount rate. The longer an activity
is delayed in the analysis, the more it is discounted (unless the discount rate is negative)
and the less impact it has on the present worth of the cash flows associated with the
alternative. The timing of early rehabilitation activities is particularly important to the
economic analysis.

It is worth remembering that pavement costs are only a portion (often small) of overall
project costs, which depend on the location and type of work being performed. For
example, pavement costs may be less than 10 percent of a project that includes many
bridges, the acquisition of right-of-way, and a great deal of traffic control. Conversely,
pavement costs may comprise almost the entire cost of projects constructed along existing
alignments with low traffic or easy detours and no bridges or other structures. In the U.S.,
pavement costs make up, on average, only 37 percent of overall project costs. Therefore
increases in pavement costs of several percent for enhanced designs and improved
performance may represent project cost increases of only a few percent. For example, the
Minnesota (US) Department of Transportation enhanced the design of an urban Interstate
pavement to extend the pavement design life from 35 years to 60 years or more. The costs
of the pavement structure increased by 8 percent, but the overall project costs increased
by only 3 percent – a bargain for an increase in expected service life of more than 70
percent! Figure 5 illustrates pavement costs as percentage of project costs for typical
projects in various markets.

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 State Rds

Mun. Strts

GA Airports

Div. Hwys – Urban

Div. Hwys – Rural

County Rds

CPR

Airport

0% 20% 40% 60% 80%

Figure 5. Pavement costs as a percentage of overall project costs for various U.S.
markets and applications (graphic courtesy of American Concrete Pavement
Association).

8. ACKNOWLEDGMENTS

The author gratefully acknowledges the following individuals and organizations for
providing many of the ideas and graphics presented in this paper: the American Concrete
Pavement Association, James Mack of the Cement Council of Texas, the U.S. Federal
Highway Administration, the Minnesota Department of Transportation, and Matt Zeller and
the Concrete Paving Association of Minnesota.

9. REFERENCES

[1] U.S. Bureau of Labor Statistics, 2007 ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

(last accessed 7/17/2007).
[2] U.S. Bureau of Labor Statistics, 2007a. http://data.bls.gov/PDQ/servlet/Survey
OutputServlet (last accessed 7/17/2007)
[3] FHWA, 2006. http://www.fhwa.dot.gov/infrastructure/asstmgmt/lccasoft.htm (last
accessed 7/17/2007).
[4] National Highway Institute, 1999. Participant’s Manual for Value Engineering
Workshop. National Highway Institute. Washington, D.C.

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