Life Cycle Costing

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When evaluating capital investment options, using Life Cycle Costing (LCC) can help you determine the option which is most cost effective. Rather then evaluating projects solely on the basis of initial costs, LCC looks at the total cost of owning, operating and maintaining a project over its useful life (including its fuel, energy, labour and replacement components). Life cycle costing calculates operating and maintenance costs incurred during the lifetime of the project plus the initial capital costs.

Life cycle costing often shows that a project with a higher initial cost may be more financially beneficial in the long run. It is especially useful for evaluating energy efficiency projects since they often require a higher initial investment but have lower operating and maintenance costs over the life of the project.

By overlooking the purchase of energy-efficient products because their initial costs maybe higher, businesses may save money in the short-term but will end up paying more for the project through higher energy costs and other operating costs over the life of the project.

Life cycle cost example

Company X is considering whether to pursue Project A or Project B.

Project B has an initial cost of $2,000, while Project A has an initial cost of $3,000. Company X is more inclined to take on Project B because of the perceived lower cost. However, applying the life cycle cost formula will help Company X determine if Project B is truly more cost-effective than Project A.

Calculating life cycle cost

The formula for calculating life cycle cost is:

LIFE CYCLE COST =
INITIAL COST + (ANNUAL COSTS x PROJECT LIFE x DISCOUNT FACTOR)

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.