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A Nirjhar Chakravorti Presentation

Life Cycle Cost Analysis

Nirjhar Chakravorti has completed Mechanical Engineering in 2000 from Jalpaiguri Government Engineering College, India. Nirjhar has experience in design, development and project engineering. During professional life, Nirjhar has worked on different engineering activities, like design, development and project engineering, along with the analysis of life cycle costing for capital expenditure of a profit making company.

Life Cycle Cost (LCC)
 Life

cycle costing, LCC, is the process of economic analysis to asses the total cost of ownership of a product, including its cost of installation, operation, maintenance, conversion, and/or decommission.

.Life Cycle Cost (LCC)  By using LCC. total cost of the product can be calculated over the total span of product life cycle.

.  This analysis provides important inputs in the decision making process in the product design. development and use.Life Cycle Cost (LCC)  LCC is a economic tool which combines both engineering art and science to make logical business decision.

. product suppliers can evaluate various operating and maintenance cost strategies (to assist product users).LCC for product supplier  By using LCC.  By using LCC. product suppliers can optimize their design by evaluation of alternatives and by performing tradeoff studies.

LCC for customer  By using LCC.  By using LCC. customers can evaluate and compare alternative products. customers can assess economic viability of projects or products. .

.  Production wants to maximize operation hours as the only criteria.Why use LCC? Typical conflict in most of the company:  Project Engineering wants to minimize capital costs as the only criteria.  Shareholders want to increase stockholder wealth as the only criteria.  Accounting wants to maximize project net present value as the only criteria.  Reliability Engineering wants to nullify failures as the only criteria.  Maintenance Engineering wants to minimize repair hours as the only criteria.

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

Why use LCC?  Why should engineers be concerned about cost elements? It is important for engineers to think like managers and act like engineers for a profit maximizing organization. Money Does Matter!!! .

. and 2) Operation & Maintenance Cost  The identification of cost elements and their sub-division are based on the purpose and scope of the LCC study.Cost element  For an equipment. there are TWO cost elements: 1) Initial Cost.

. – Investment on asset. – Installation cost or erection & commission cost.Cost element  Initial Cost: – Design & development cost. or cost of equipment.

– Energy cost.Cost element  Operation & Maintenance Cost: – Labour cost. . – Spare & maintenance cost. – Raw material cost.

Computation of Life Cycle Cost Analysis (Steps for LCCA) .

 Step 2: Estimate value of each cost element.  Step 5: Analyze the results.  Step 3: Calculate Net Present Value of each element.Steps for computation of LCC Step 1: Determine time for each cost element. for every year (over its time period).  Step 4: Calculate LCC by adding all cost element. at every year.  .

To be continued…… .Step 1: Determination of time – Determination of life cycle of the product (i. in this case). starting from launch of the product up to the time when company withdraw the product from the market. That is purely a marketing concept.e. Conventional concept of Product Life Cycle implies to the time span based on demand of the product in the market. equipment. This Life cycle is not similar to conventional concept of Product Life Cycle.

i.e. how long he/ she wants to use the machine. customer decides the Life Cycle. – Based on supplier’s data. also. technological obsolescence and economic uncertainty factor. – The product supplier provides the life cycle depending on design calculation and experience.e. life cycle means the life of the product that is installed in the plant. i. To be continued…… . Customer considers the effect of available maintenance facility.Step 1: Determination of time – In LCC analysis of an equipment. productive life time of the product.

say.Step 1: Determination of time – After that. . among which first one year will be initial cost zone and remaining 9 years will be under operation and maintenance cost zone. – Example. company decides the time span for each component. a company decides that total life cycle of the product will be 10 years from the allocation the fund.

e.Step 2: Estimation of value – Estimate monetary value for each cost element. . This value is basically future income at each year. calculation based on facts and experience. – To estimate the value. which is estimated. various source can be used. etc.g. – This estimated value will be incurred in every year. MIS report for similar existing machines.

To be continued…… .Step 3: Net Present Value – Money has a time value. – The present value of future income or future cost can be calculated by using discounting factor and inflation factor.

To determine the present value of this Rs. a central bank charges depository institutions that borrow reserves from it.09 to Ram today (i. 909. 1000/[1+0. Ram expects Rs. – For example.000 in a year's time would be equivalent of Rs. 1.e. Assuming a discount rate of 10%.000 Ram would need to discount it by a particular rate of interest (often the risk-free rate but not always).000 in one year's time. let's say Mr. 1.10]).Step 3: Net Present Value  Discount factor – The discount rate is an interest rate. the Rs. To be continued…… . 1.

It is the rate by which the purchasing power of the people in a particular geography has declined in a specified period.Step 3: Net Present Value  Inflation factor – The inflation rate is the percentage by which prices of goods and services rise beyond their average levels. To be continued…… .

C = any cost element at nth year I = inflation rate d = discount rate/ interest rate .Step 3: Net Present Value  Formula for Net Present Value (NPV) C (1+i/100) (n-1) PV= ----------------------(1+d/100) n where.

LCC is calculated for every year.  PVs of each cost element in a year are added.e.  . i.Step 4: Summation of PVs PVs of each cost elements is calculated for an equipment (at every year).  The process is done for every year over the life cycle.

political and environmental concerns are taken into account.  Datas for every product are analyzed. available budgets. then LCC is calculated for every product. and the lowest LCC option become preferred.  If one product has to be selected among multiple equipments.Step 5: Analysis The datas collected from LCC are analyzed.  But lowest LCC option may not necessarily be implemented when other considerations such as risk.  .

. but not the final answer..An important reminder…. LCC provides critical information to the overall decision-making process.

Estimation of Life Cycle Cost With a typical case study! .

A highly productive foundry shop has one sophisticated robot operated core making machine (made in Italy). Due to increase of demand for its casting. 2. . there are two options: Similar sophisticated robotic machine. or Semi-automated machine.Case Study    1. For new machine. the foundry shop wants to install one new core making machine.

No. Remarks 1 2 3 Design & development (D) Investment on asset (A) Installation (I) 59.4 0. phase million)/ year Sl.Option 1  Initial cost Cost Element Value Time (in INR.6 0-1 year 0-1 year Bought out item 1% of asset cost .

d=8% Inflation rate.+ --------------------(1+8/100) 1 (1+8/100) 1 (1+8/100) 1 From calculation.06(1+5/100) 0 PV= ----------------------. only Interest rate.4(1+5/100) 0 0. i=5% 0(1+5/100) 0 59.+ ----------------------(1+d/100) n (1+d/100) n (1+d/100) n n is the year on which PV will be calculated.+ ---------------------. here n=1 year.5 million INR . PV of IC = 55.Option 1 Initial cost (IC) Computation of PV of IC  D(1+i/100) (n-1) A(1+i/100) (n-1) I(1+i/100) (n-1) PV= -----------------------.+ -----------------------.

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

6 Million INR PV of OC at nth year. .Option 1 Operation & Maintenance cost (OC) Computation of PV of OC Total OC= L+E+S+M=34.  OC(1+i/100) (n-1) PV= -----------------------(1+d/100) n Cumulative value of OC after nth year (in terms of PV) OC(1+i/100) (n-1) = Ʃ -----------------------(1+d/100) n PV of OC and cumulative OC at different year to be calculated by using this formula.

83 27.54 0.63 0.57 Total PV incurred Million INR F=E+ last year's F 31.86 0.50 Inflation factor (1+5/100)n-1 C 1.50 55.38 200.60 Time Period nth year A 1 2 3 4 5 6 7 8 9 Discounting factor 1/(1+8/100)n B 0.10 1.50 55.48 PV of any year Million INR E=DXBXC 31.37 174.50 55.50 55.62 27.30 25.86 251.28 29.60 24.93 146.Option 1  COMPUTATION OF LCC: TABLE 1 Operation & Maintenance cost (OC) Future OC at nth year Million INR D 34.58 0.05 1.79 0.87 119.60 34.43 90.50 55.15 61.60 34.15 30.68 226.50 Total LCC Million INR H=G+F 55.60 34.61 .32 174.05 26.28 1.50 55.65 116.82 229.46 1.11 55.18 281.25 Initial Cost (IC) Million INR G 55.88 256.60 34.44 28.60 34.68 0.75 10 0.22 1.74 0.50 306.41 1.50 55.16 1.60 34.50 86.60 34.99 202.55 34.34 1.50 55.49 147.

This expected value can be different for different years. too.6 Million INR.Option 1  Computation of LCC In the previous calculation.e. . i. expected future values of OC at all the years were same. 34.

Option 2  Different cost element for option 2 (i.e. . Semi-automated machine) has been estimated and final calculation for LCC has been done.

00 42.10 38.58 0.00 42.00 50.41 1.99 332.31 172.88 42.55 50.00 35.48 PV of any year Million INR E=DXBXC 45.36 40.00 50.00 42.68 212.95 10 0.50 Inflation factor (1+5/100)n-1 C 1.00 326.00 50.63 0.95 Initial Cost (IC) Million INR G 42.89 251.01 36.46 1.00 404.00 50.74 0.00 50.01 88.00 Total LCC Million INR H=G+F 42.00 42.68 254.Option 2  COMPUTATION OF LCC: TABLE 2 Operation & Maintenance cost (OC) Future OC at nth year Million INR D 50.79 0.01 130.16 1.88 .54 41.77 131.68 0.31 214.00 42.00 50.05 1.76 42.54 0.34 1.21 39.00 50.00 Time Period nth year A 1 2 3 4 5 6 7 8 9 Discounting factor 1/(1+8/100)n B 0.93 362.10 1.00 87.01 43.86 0.00 42.89 293.00 42.77 173.99 290.00 368.00 42.95 Total PV incurred Million INR F=E+ last year's F 45.22 1.28 1.

in Million) 350 300 250 200 150 100 50 0 1 2 3 4 5 6 7 8 9 10 Time (Year) Option 1: Robotic M/c Option 2: Semi-Auto M/c .Analysis Life Cycle Cost Analysis 450 400 LCC (INR.

the robotic machine is preferred compared to the semiautomated machine. .  Considering LCCA.Analysis  The analysis shows: – initial cost of semi-automated machine is lower. the long term LCC is much lower for Robotic machine. for this particular application. – But.

 LCC is one of the useful tool which enables investors to analyze investment in terms of economic behaviour. capital expenditure should be defined in terms of economic behaviour rather than in terms of accounting convention.  Economist Joel Dean has suggested that.  .Capital Budgeting & LCC LCC is one of the important tool for capital budgeting.

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