My initial inspection of the LCCA showed the analysis was flawed: All of the upfront costs for each option were not included and neither was the cost of energy. Once I got further into the analysis I noticed the person performing the original LCCA also neglected to include some costs for maintenance.
When I revised the LCCA, what was first determined to be the hands down choice came in as essentially a tie with one of the options previously disregarded.
Given the apparent misunderstanding of how to perform an LCCA, I decided to provide a quick overview of the process.
A life cycle cost analysis is the process of economic analysis to determine the total cost of ownership of a product or system, including the cost of installation, operation, maintenance, conversion and/or decommission/salvage. This analysis can be for a complete building, HVAC system, insulation options, roof repair options, pavement type, etc.
The LCCA is the total life-cycle cost in present value (PV) dollars of a given alternative. This means general price inflation, as well as energy price indices and discount factors, may be needed. Some engineers find this the most difficult part of an LCCA.
General price inflation measures the decline in the purchasing power of the dollar over time. In other words, a dollar now buys more than a dollar in the future. There are two approaches for dealing with general price inflation when performing an LCCA: Current dollar analysis and constant dollar analysis. Current dollars are dollars of any single year's purchasing power, inclusive of inflation; they reflect changes in the purchasing power of the dollar from year to year. Constant dollars are dollars of uniform purchasing power, not taking inflation into account. Constant dollars indicate what the same good or service would cost at different times if there were no general inflation or deflation (i.e., no change the purchasing power of the dollar). It should be noted that some agencies and lenders require either the use of current or constant dollars. Make sure you know what your client requires prior to finalizing the analysis.
LCCA calculations for building systems typically treat general price inflation using a constant dollar approach. This avoids the need to project future rates of inflation or deflation, thus reducing unnecessary complexity and uncertainty. The price of a good or service stated in constant dollars is not affected by the rate of general inflation. For example, if the price of a piece of equipment is $10,000 today and $10,500 at the end of a year in which prices in general have risen at an annual rate of 5%, the price stated in constant dollars is still $10,000; no inflation adjustment is necessary. However, if cash flows are stated in current dollars, future amounts include an assumed general inflation rate and an adjustment is necessary to convert the current-dollar estimate to its constant-dollar equivalent.
LCCAs typically assume prices for all goods and services, other than for energy and water, will increase at approximately the same rate as general inflation. However, if there is specific information for assuming prices change at a rate different than general inflation (i.e., when price escalation rates are established in a maintenance contract), these rates should be used in the analysis.
Another factor used when performing an LCCA is the discount rate. Discount rate is function of interest rate and inflation rate. Interest rate is cost of borrowing money (i.e., earning power of money). Inflation rate is rate of increase in prices of goods and services (i.e., changes in purchasing power of money). Producers Price Index (PPI) is a reasonable reflection of the inflation rate.
For practical purposes: I discount ≈ I interest – I inflation
The federal discount rates for measures not associated with energy and water, as published by the Federal Office of Management and Budget, can be found here:
The selection of a discount rate in an LCCA can be a bone of contention due to the amount of uncertainty associated with future interest rates and inflation. Too low a discount rate would overemphasize the influence of uncertain future costs. Too high a discount rate would overemphasize the importance of the initial cost. If your projects are highly dependent upon the discount rate, bringing in an expert on this subject is recommended.
Much more information on discount rates and how to determine which one to use can be found here: http://www.rits.rutgers.edu/files/discountrate_lifecycle.pdf
Energy and water prices are treated differently than the cost of materials and goods because energy and water prices will not inflate at the same rate as other goods and services. Therefore, general price inflation is differentiated from energy price inflation by using the term energy price "escalation." As with the use of the discount rate, the energy price escalation rates are "real" (i.e., net or differential).
The energy price indices and discount factors can be found here:
The basic equation for an LCCA is:
LCC = I + Repl - Res + E + W + OM&R + O
I: Initial cost
Repl:Capital replacement costs
Res: Residual value (resale/salvage value) less disposal costs
E: Total energy cost
W: Total water costs
OM&R: Total operating, maintenance, and repair costs
O: Total other costs, such as contract administration costs, financing costs, employee salaries and benefits, etc.
As you gather information for the analysis, make sure to document where data came from as well as any assumptions made. Memories fade over time and in the event questions about the analysis arise, you want to be able to answer them as quickly as possible.
Upon completion of the LCCA, a sensitivity analysis should be performed. A sensitivity analysis shows how significantly the results change due to potential variations in input data. If a change in a variable causes a change in the ranking of alternatives, the LCCA is “sensitive” to that variable. Good engineering judgment should be used in selecting the most important input variables that will be included in the sensitivity analysis. Performing a sensitivity analysis, and including its results in the report, assures the decision maker uncertainties in the LCCA have been tested and the results documented. At a minimum, a sensitivity analysis should be considered as part of the analysis of benefits and costs; the discount rate; and potential variations in energy and water costs.