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7/27/2019 lifecyclecostanalysisbynirjhar-090720140508-phpapp01

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Life Cycle Cost Analysis


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What is Life Cycle Cost (LCC)

Analysis?

A method of calculating the cost ofa system over its entire life span.


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Objectives of LCC Analysis

Evaluate the economiceffectiveness of different mutuallyexclusive investment alternatives

over a certain period

Identify the most cost-effectivealternative


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Life Cycle Cost (LCC)

Life cycle costing, LCC, is the processofeconomic analysis to asses the

total cost of ownership of a product,including its cost ofinstallation,operation, maintenance, conversion,

and/or decommission.


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By using LCC, total cost of theproduct can be calculated over the

total span of product life cycle.


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LCC is a economic tool whichcombines both engineering art and

science to make logical businessdecision.

This analysis provides important

inputs in the decision making processin the product design, developmentand use.


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LCC for product supplier

By using LCC, product suppliers canoptimize their design by evaluation of

alternatives and by performing trade-off studies.

By using LCC, product suppliers can

evaluate various operating andmaintenance cost strategies (to assistproduct users).


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LCC for customer

By using LCC, customers can evaluateand compare alternative products.

By using LCC, customers can assesseconomic viability of projects orproducts.


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Why use LCC?

Typical conflict in most of the company: Project Engineering wants to minimize capital

costs as the only criteria, Maintenance Engineering wants to minimize

repair hours as the only criteria, Production wants to maximize operation hours

as the only criteria, Reliability Engineering wants to nullify failures

as the only criteria,Accounting wants to maximize project net

present value as the only criteria, Shareholders want to increase stockholder

wealth as the only criteria.


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Why use LCC?

LCC can be used as a managementdecision tool for synchronizing the

divisional conflicts by focusing onfacts, money, and time.


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Why use LCC?

Why should engineers be concernedabout cost elements?

It is important for engineers to think like

managersand act like engineersfor aprofit maximizing organization.

Money Does Matter!!!


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Cost element

For an equipment, there are TWO costelements:

1) Initial Cost, and2) Operation & Maintenance Cost

The identification of cost elements and theirsub-division are based on the purpose and scopeof the LCC study.


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Cost element

Initial Cost:

Design & development cost,

Investment on asset, or cost ofequipment,

Installation cost or erection &

commission cost.


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Cost element

Operation & Maintenance Cost:

Labour cost,

Energy cost, Spare & maintenance cost,

Raw material cost.


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Computation

ofLife Cycle Cost Analysis

(Steps for LCCA)


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Steps for computation of LCC

Step 1: Determine time for each costelement,

Step 2: Estimate value of each cost element,

Step 3: Calculate Net Present Value of eachelement, for every year (over its timeperiod),

Step 4: Calculate LCC by adding all costelement, at every year,

Step 5: Analyze the results.


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Step 1: Determination of time

Determination of life cycle of theproduct (i.e. equipment, in thiscase).

This Life cycle is not similar toconventionalconcept of Product Life Cycle.

Conventional concept of Product Life Cycle

implies to the time span based on demand ofthe product in the market, starting fromlaunch of the product up to the time whencompany withdraw the product from the

market. That is purely a marketing concept.To be continued


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In LCC analysis of an equipment, life cyclemeans the life of the product that is installed inthe plant, i.e. productive life time of theproduct.

The product supplier provides the life cycledepending on design calculation andexperience.

Based on suppliers data, customer decides the

Life Cycle, i.e. how long he/ she wants to usethe machine. Customer considers the effect ofavailable maintenance facility, technologicalobsolescence and economic uncertainty factor,

also. To be continued


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After that, company decides the timespan for each component.

Example, say, a company decides that

total life cycle of the product will be 10years from the allocation the fund,among which first one year will be initial

cost zone and remaining 9 years will beunder operation and maintenance costzone.


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Step 2: Estimation of value

Estimate monetary value for each costelement.

This estimated value will be incurred inevery year. This value is basically futureincome at each year, which is estimated.

To estimate the value, various sourcecan be used; e.g. calculation based onfacts and experience, MIS report forsimilar existing machines, etc.


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Step 3: Net Present Value

Money has a time value.

The present value of future income orfuture cost can be calculated by usingdiscounting factor and inflation factor.

To be continued


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Discount factor The discount rate is an interest rate, a

central bank charges depository

institutions that borrow reserves from it. For example, let's say Mr. Ram expects Rs. 1,000

in one year's time. To determine the presentvalue of this Rs. 1,000 Ram would need todiscount it by a particular rate of interest (oftenthe risk-free rate but not always). Assuming adiscount rate of 10%, the Rs. 1,000 in a year'stime would be equivalent of Rs. 909.09 to Ram

today (i.e. 1000/[1+0.10]). To be continued


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Inflation factor

The inflation rate is the percentage bywhich prices of goods and services risebeyond their average levels. It is the rateby which the purchasing power of thepeople in a particular geography has

declined in a specified period.

To be continued


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Formula for Net Present Value (NPV)

C (1+i/100) (n-1)

PV= -----------------------

(1+d/100) n

where,C = any cost element at nth year

I = inflation rate

d = discount rate/ interest rate


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Step 4: Summation of PVs

PVs of each cost elements is calculated foran equipment (at every year).

PVs of each cost element in a year are

added.

The process is done for every year over thelife cycle, i.e. LCC is calculated for every

year.


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Step 5: Analysis

The datas collected from LCC are analyzed.

If one product has to be selected amongmultiple equipments, then LCC is calculated

for every product. Datas for every product are analyzed, and

the lowest LCC option become preferred.

But lowest LCC option may not necessarilybe implemented when other considerationssuch as risk, available budgets, political andenvironmental concerns are taken into

account.


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An important reminder..

LCC provides critical information to theoverall decision-making process, but notthe final answer.


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Backflush Costing


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Backflush Costing

Backflush costing describes a costing

system that omits recording some or

all of the journal entries relating to the

cycle from purchase of direct materials

to the sale of finished goods.


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Backflush Costing

Where journal entries for one or more stages

in the cycle are omitted, the journal entries

for a subsequent stage use normal or standard

costs to work backward to flush out the costs in

the cycle for which journal entries were not made.


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A product costing system generally used ina just-in-time inventory environment.Backflush costing delays the costing

process until the production of goods iscompleted. Costs are then flushed backat the end of the production run and

assigned to the goods. This eliminates thedetailed tracking of costs throughout theproduction process, which is a feature of

traditional costing systems.


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Contd..

By eliminating work-in-process accounts,backflush costing simplifies the accountingprocess. However, this simplification and

other deviations from traditional costingsystems mean that backflush costing maynot always conform to generally accepted

accounting principles (GAAP). Anotherdrawback of this system is the lack of asequential audit trail.

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