6.2 Life Cycle Costs
In the Evaluation Methods chapter, we discussed many methods which an investor might use to choose between mutually exclusive projects. The drawback of many of these methods is that they do not account for every economic factor which might impact a project. For example, the Capital Recovery Cost (CRC) method considered the initial price and final salvage value of a project, but did not consider other cash flows such as maintenance costs or revenues. The purpose of life cycle costing is to look at all of the costs related to a project, so that its cost-effectiveness can be evaluated with greater confidence.
Life cycle cost (LCC) is the total cost of a project over its life including planning, design, acquisition, support costs, and decommissioning, as well as any other costs directly attributable to owning or using the asset. These costs encompass the entire life cycle of a project and thus are sometimes referred to as “cradle to grave” costs. They are typically measured or estimated in advance, however, life cycle costing can be applied at any phase of a project’s life. It can provide insight into how the manufacturing, installation, operation, maintenance, or disposal of an existing project can be executed economically. The major advantages of performing life cycle costing at the outset are that cost-effective decisions will have a greater influence on the total cost of a project if they are enacted early, and identifying project costs in advance allows an investor to account for their preferences (performance, reliability, maintenance, etc.) before beginning a project.
When estimating the LCC of a project, we break down the total cost of the project into smaller elements whose costs can be estimated more easily. These costs can be broken down by the significant components of a project, the time when they occur in the project life cycle, and the category of resource cost they fall under (e.g. labour, materials, energy, etc.).
Consider the construction of a new highway. The costs for this project could be broken down into several major components, such as the design process, surveying the route, constructing the embankment, completing the road surface, and long-term maintenance costs (e.g. crack filling and snow removal). Each of these phases could be broken down into smaller cost components. For example, the construction of the road embankment would entail labour costs for labourers and geotechnical staff, material costs for the soil used as well as transportation costs to bring it to the work site, and equipment and fuel costs for operating the necessary construction vehicles. Each of these costs would be attached to a certain time period in the project life cycle. The provincial or federal government constructing the highway must look at the long term cost of maintaining the highway, which will influence the design process, construction process, and material choice. For example, a certain type of pavement might be more exp