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The document is a report on life cycle costing submitted by Shahnoor Shafi to their instructor Sir Maqbool ur Rehman. It includes an introduction to life cycle costing, an acknowledgement section thanking those who helped with the report, and an executive summary outlining what will be covered in the report. The report will provide an overview of life cycle costing, its definition and uses, a SWOT analysis, a literature review of 5 articles, and how life cycle costing can be implemented in Pakistan with an example calculation.
The document is a report on life cycle costing submitted by Shahnoor Shafi to their instructor Sir Maqbool ur Rehman. It includes an introduction to life cycle costing, an acknowledgement section thanking those who helped with the report, and an executive summary outlining what will be covered in the report. The report will provide an overview of life cycle costing, its definition and uses, a SWOT analysis, a literature review of 5 articles, and how life cycle costing can be implemented in Pakistan with an example calculation.
The document is a report on life cycle costing submitted by Shahnoor Shafi to their instructor Sir Maqbool ur Rehman. It includes an introduction to life cycle costing, an acknowledgement section thanking those who helped with the report, and an executive summary outlining what will be covered in the report. The report will provide an overview of life cycle costing, its definition and uses, a SWOT analysis, a literature review of 5 articles, and how life cycle costing can be implemented in Pakistan with an example calculation.
SHAHNOOR SHAFI- 13361 29 TH APRIL 2013 LETTER OF TRANSMITTAL
Sir Maqbool ur Rehman Instructor for Advanced Managerial Accounting Institute of Business Management Karachi.
Dear Sir, I request you to accept this report on LIFE CYLE COSTING that you assigned during semester spring 2013. It has been a privilege to work on this project and I have put in my utmost effort to prepare a comprehensive report on this topic. If you will be having any queries regarding this report I will be happy to discuss it with you.
Sincerely, SHAHNOOR SHAFI 13361
ACKNOWLEDGEMENT
Firstly and foremost I would like to thank Almighty Allah who gave me the strength to carry out this research activity. Secondly, I would also like to thank Sir Maqbool ur Rehman for the valuable guidance and advice. He inspired me greatly to work on this report. His willingness to motivate me contributed tremendously to my report. Finally, an honorable mention goes to my families and friends for their understandings and supports on me in completing this project. Without the support of the above mentioned it wouldnt have been possible.
EXECUTIVE SUMMARY
The following report gives an overview of life cycle costing. Moreover, the report will briefly outline the definition of life cycle costing, use of life cycle costing, swot analysis on life cycle costing and literature review of five different articles. The report will further focus on the implementation of life cycle costing in Pakistan.
TABLE OF CONTENTS
Table of Contents
LETTER OF TRANSMITTAL ACKNOWLEDGEMENT EXECUTIVE SUMMARY TABLE OF CONTENTS INTRODUCTION ............................................................................................................................................. 1 WHY USE LCC? ............................................................................................................................................... 2 STEPS FOR COMPUTATION OF LCC ............................................................................................................... 3 SWOT ANALYSIS ............................................................................................................................................ 5 LITERATURE REVIEW ..................................................................................................................................... 6 IMPLEMENTATION IN PAKISTAN................................................................................................................. 11 CALCULATING LCC: AN EXAMPLE ................................................................................................................ 12 REFERENCES ................................................................................................................................................ 13
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INTRODUCTION
Life-cycle costing is a method for assessing the total cost of facility ownership. It takes into account all costs of acquiring, owning, and disposing of a building or building system. LCC is especially useful when project alternatives that fulfill the same performance requirements, but differ with respect to initial costs and operating costs, have to be compared in order to select the one that maximizes net savings. LCC is a tool to calculate the economic costs caused by a product or a service during its entire life cycle, from purchase of raw material and components, cost of production and investments to usage, maintenance and waste management. There are no international standards for LCC. The scope of LCC studies is mostly more limited than the scope of LCA studies. An LCC study may for example start at the gate of suppliers, where raw material extraction and refining processes are not accounted for. In most cases, LCC studies end at the part of the life cycle where costs for waste management occur. Thus, LCC studies consider purchase, maintenance, use and end-of-life handling costs of the product. LCC is particularly suitable for evaluation of design alternatives that satisfy a specified performance level. An LCC may show that different alternatives have different investment, operating, maintenance or repair costs, and possibly different life spans. LCC can be applied to any capital investment decision. It is most relevant when high initial costs are traded for reduced future cost. The life-cycle cost of an asset can be expressed by the simple formula: LCC = capital cost + life-time operating costs + life-time maintenance costs + disposal cost - residual value.
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WHY USE LCC?
LCC helps change provincial perspectives for business issues with emphasis on enhancing economic competitiveness by working for the lowest long term cost of ownership which is not an easy answer to obtain. Consider these typical problems and conflicts observed in most companies: 1. Project Engineering wants to minimize capital costs as the only criteria, 2. Maintenance Engineering wants to minimize repair hours as the only criteria, 3. Production wants to maximize uptime hours as the only criteria, 4. Reliability Engineering wants to avoid failures as the only criteria, 5. Accounting wants to maximize project net present value as the only criteria, and 6. Shareholders want to increase stockholder wealth as the only criteria. Management is responsible for harmonizing these potential conflicts under the banner of operating for the lowest long term cost of ownership. LCC can be used as a management decision tool for harmonizing the never ending conflicts by focusing on facts, money, and time. Why should engineers be concerned about cost details for LCC? It is important to help engineers think like MBAs and act like engineers for profit making enterprises--Its all about the money! Other than that by using LCC, product suppliers can optimize their design by evaluation of alternatives and by performing trade-off studies. And customers can evaluate and compare alternative products. They can also assess economic viability of projects or products.
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STEPS FOR COMPUTATION OF LCC
STEP 1: DETERMINE TIME FOR EACH COST ELEMENT Determination of life cycle of the product (i.e. equipment, in this case). This Life cycle is not similar to conventional concept of Product Life Cycle. Conventional concept of Product Life Cycle implies to the time span based on demand of the product in the market, starting from launch of the product up to the time when company withdraw the product from the market. That is purely a marketing concept. Determination of time In LCC analysis of equipment, life cycle means the life of the product that is installed in the plant, i.e. productive life time of the product. The product supplier provides the life cycle depending on design calculation and experience. Based on suppliers data, customer decides the Life Cycle, i.e. how long he/ she wants to use the machine. Customer considers the effect of available maintenance facility, technological obsolescence and economic uncertainty factor, also. After that, company decides the time span for each component. Example, say, a company decides that total life cycle of the product will be 10 years from the allocation the fund, among which first one year will be initial cost zone and remaining 9 years will be under operation and maintenance cost zone. STEP 2: ESTIMATE VALUE OF EACH COST ELEMENT Estimation of value Estimate monetary value for each cost element. This estimated value will be incurred in every year. This value is basically future income at each year, which is estimated. To estimate the value, various sources can be used; e.g. calculation based on facts and experience, MIS report for similar existing machines, etc.
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STEP 3: CALCULATE NET PRESENT VALUE OF EACH ELEMENT, FOR EVERY YEAR (OVER ITS TIME PERIOD) 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. Net Present Value Discount factor the discount rate is an interest rate, a central bank charges depository institution that borrow reserves from it. For example, let's say Mr. Ram expects Rs. 1,000 in one year's time. To determine the present value of this Rs. 1,000 Ram would need to discount it by a particular rate of interest (often the risk-free rate but not always). Assuming a discount rate of 10%, the Rs. 1,000 in a year's time would be equivalent of Rs. 909.09 to Ram today (i.e. 1000/[1+0.10]). Net Present Value Inflation factor: The inflation rate is the percentage by which prices of goods and services rise beyond their average levels. It is the rate by which the purchasing power of the people in a particular geography has declined in a specified period.
STEP 4: CALCULATE LCC BY ADDING ALL COST ELEMENT, AT EVERY YEAR Summation of PVs of each cost elements is calculated for equipment (at every year). PVs of each cost element in a year are added. The process is done for every year over the life cycle, i.e. LCC is calculated for every year. STEP 5: ANALYZE THE RESULTS. Analysis the data collected from LCC are analyzed. If one product has to be selected among multiple equipment, then LCC is calculated for every product. Data for every product are analyzed, and the lowest LCC option becomes preferred. But lowest LCC option may not necessarily be implemented when other considerations such as risk, available budgets, political and environmental concerns are taken into account.
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SWOT ANALYSIS
STRENGTHS It contributes to the evaluation of the economic dimension of sustainability. By evaluating the costs in relation to the environmental effects, it is possible to appreciate the impact that a cost saving can have on environmental effects. Makes it possible to take into consideration future costs at an early stage and relate them to the initial costs. Gives the investment analysis an expanded time perspective and enable an investigation of the environmental costs which can make visible future revenues. the process of realizing an LCC stimulates learning.
WEAKNESSES lack of uniform practices, common approaches and measures, difficulties in defining some of the cost factors, difficulties in evaluation of the effects of the changes in a products operational conditions, too many factors of uncertainty, and poor quality of data from suppliers and lack of comprehensive data for products performance in the operational phase.
OPPORTUNITIES Within the EU policies there exists a growing interest of life cycle thinking and especially to enhance the use of the LCC
THREATS There are few scientific journals that focus on environmental LCC There is no generic data format for Environmental LCC, There are no adequate databases; cost information is much more variable over time than life cycle inventory data; therefore static databases are not very useful for LCC, There is insufficient knowledge and lack of quality training, and There is often limited cooperation between clients and suppliers, 6 | P a g e
LITERATURE REVIEW
ARTICLE NO.1 JOURNAL ARTICLE ELSEVIER Life cycle cost based procurement decisions: A case study of Norwegian Defense Procurement projects. ( 4 September 2007) AUTHOR Bernt E. Tysseland IMPACT FACTOR No impact RESEARCH OBJECTIVE What can explain that some procurement projects are still carried out and reviewed based on initial procurement costs alone when the official policy is to apply the life cycle cost approach? RESEARCH MODEL Dependent variable: -Use of LCC. Independent variables: - Project uncertainty - Attitude towards LCC - Information symmetry - Knowledge of LCC RESEARCH DESIGN
DATA ANALYSIS The measuring instrument of choice is a questionnaire with a sample size of 150 respondents. Hypothesis testing using SPSS Regression Analysis on cost elements Anova CONCLUSION - If the project uncertainty is high the project board would be more informed about the use of LCC. - The positive attitude of the project leader will positively affect the use of LCC. - It is very likely that information symmetry between the principal and the agent really makes a unique contribution to the use of LCC. - Lack of knowledge is reason why LCC is not used.
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ARTICLE NO.2 JOURNAL ARTICLE ELSEVIER The life cycle costing (LCC) approach: a conceptual discussion of its usefulness for environmental decision-making. 16 October 2003 AUTHOR Pernilla Glucha, Henrikke Baumann IMPACT FACTOR No impact ABSTRACT The purpose of this article is to discuss theoretical assumptions and the practical usefulness of the LCC approach in making environmentally responsible investment decisions. LCCs monetary unit and extended scope may speak in favour of using LCC but LCC fails to handle irreversible decisions, neglects items that have no owner and does not consider costs to future generations. To handle these inconsistencies in future development of environmental decision support tools three research solutions are proposed. CONCLUSION - In order to raise the decision makers trust in the results from LCC, the availability and reliability of data must be secured. - Extend the system boundaries by complementing LCC-oriented tools with tools that focus on physical measures. - Improve the understanding of environmentally related decision-making and use of tools.
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ARTICLE NO.3 ARTICLE EduBuilding: Material Selection from Life Cycle Costing Sensitivity. 2010 AUTHOR Mat Noor N. A. Chris Eves IMPACT FACTOR NO IMPACT ABSTRACT The purpose of this research is to examine the Life Cycle Cost Analysis on building floor materials. By implementing the life cycle cost analysis, the true cost of each material will be computed projecting 60 years as the building service life and 5.4% as the inflation rate percentage to classify and appreciate the different among the materials. The analysis results showed the high impact in selecting the floor materials according to the potential of service life cycle cost next. HYPOTHESIS The hypothesis of this research is that a low initial capital cost of a material will result in a life cycle cost higher than the cost benefit of the initial purchase. Initial Capital Cost = LCCA Cost Benefit CONCLUSION A low life cycle cost material may not be suitable for the requirements associated with an educational asset. Materials characteristics and properties must be considered before selecting any flooring material. Life cycle cost quantitative results should only be used as partial indicators and not a final decisive tool for the selection of interior flooring surfaces.
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ARTICLE NO. 4 ARTICLE LIFE CYCLE COST CALCULATION: MODELS FOR BUILDINGS. 2005 AUTHOR Erika Levander, Jutta Schade and Lars Stehn IMPACT FACTOR No impact ABSTRACT Most commonly, production cost is the main cost factor in construction and is often set to the minimum, which does not necessarily improve the lifetime performance of buildings. However, a higher production cost might decrease total life cycle cost (LCC). This paper presents a state of the art analysis in the area of LCC for construction. The paper also reveals the primary data which are required to carry out a LCC analysis and discusses limitations in the application of life cycle costing from the clients perspective.
CONCLUSION The choice of the right calculation method for LCC is easy and obvious if the advantages and disadvantages are appreciated. If LCC is adopted as a decision making tool. The lifetime quality and the cost effectiveness of buildings would improve by using LCC in the early stage design.
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ARTICLE NO. 5 ARTICLE A method-based survey of life cycle costing literature pertinent to infrastructure design and renewal. 2005 AUTHOR Paul N. Christensen, Gordon A. Sparks, and Kent J. Kostuk IMPACT FACTOR No Impact ABSTRACT Motivated by Canadas infrastructure crisis, the Intelligent Sensing for Innovative Structures (ISIS) Canada Research Network has developed and demonstrated the efficacy of innovative materials and monitoring technologies to support infrastructure design and renewal efforts. The purpose of this paper is to review and broadly classify LCC methods evident in relevant literature. RESEARCH DESIGN Structured interview & observation CONCLUSION By following through the iterative method of LCC, both engineers and, most importantly, their customers can be reasonably assured that the design ultimately selected and pursued will deliver the required performance at minimum life cycle cost. The iterative method of LCC addresses uncertainty through explicit inclusion of sensitivity and risk analyses. Also, it acknowledges and addresses the complexity of the design process.
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IMPLEMENTATION IN PAKISTAN
There are no direct or indirect traces as to where LCC is implemented in Pakistan. This may be due to: insufficient knowledge perception of managers that LCC analysis is too complicated. lack of quality training in Pakistan There is often limited cooperation between clients and suppliers
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CALCULATING LCC: AN EXAMPLE
The formula for calculating life cycle cost is LIFE CYCLE COST = INITIAL COST + (ANNUAL COSTS x PROJECT LIFE x DISCOUNT FACTOR) PROJECT A PROJECT B Initial Cost $3,000 $2,000 Annual Costs Electricity Maintenance
$150 $50
$250 $150 Project Life (Years) 15 15 Discount Factor (Based on an interest rate of 3%) 0.64 0.64 Calculations $3,000 + ($200 x 15 x 0.64) $2,000 + ($400 x 15 x 0.64) LIFE CYCLE COST $4,920 $5,840
As the above comparison demonstrates, the lowest initial cost does not lead to the lowest cost overall. Project A is the more cost effective option to pursue.