The first task one must accomplish in performing an LCC analysis is to determine the period of time for which the analysis of accumulated costs is to occur. This will usually be designated the project design life. The life span of the facility to be analyzed (a bridge, pavement, or culvert pipe) must be determined, together with the associated maintenance and rehabilitation costs. Another consideration that must be addressed is the realization that individual life spans of components of a system may be quite different. For example, in considering a highway system, the life of a bridge will likely be much longer than the life of a pavement. In considering a building, the life of the structural framework may well be 100 years or more, whereas the life of the roof may be only 20 years.

In performing a value study, the project design life or life span that should be selected is the period of time over which the owner or user of a product or facility needs the item. The user’s need determines the life span when judging LCC and worth, and when com­paring alternatives. The life span should be a realistic, reasonable time, and the same life span must be used for evaluating all choices. Assessment of obsolescence is part of a rational determination of design life. One must estimate how far in the future the functional capacity will be adequate. An unrealistically long design life may result in excessive expenditures on initial costs. On the other hand, an unrealistically short design life may lead to expensive replacement at a premature date.

The salvage or residual value at the end of the project design life must be determined and accounted for in the analysis. This may represent a net scrap value or the value asso­ciated with the reuse of a component, if that is feasible.

10.8.1 Discount Rates

The discount rate is used to convert costs occurring at different times to equivalent costs in present dollars. The selection of the discount rate to be used in the calculations is very important. If a low discount rate is selected, greater significance is given to future expen­ditures. If a high discount rate is selected, less significance is given to future expenditures. The discount rate should represent the rate of interest that makes the owner indifferent regarding whether to pay a sum now or at a future time. In government projects, the discount rate may be mandated by policy or law. The Office of Management and Budget prescribes rules for federal projects in Circular A-94. It states that the discount rate repre­sents an estimate of the average rate of return on private investment, before taxes and after inflation. Thus, it may differ from the cost of borrowing. Guidelines on discount rates may be further amplified by federal agencies.

Life cycle cost (LCC) is the total cost of ownership of an item, computed over its useful life. To rationally compare the worth of alternative designs, or different ways to do a job (accomplish a function), an LCC analysis is made of each. For those who follow the

VE job plan, a life cycle cost analysis is very easy to perform because the total impact of each recommended VE alternative is an integral part of the total calculations. In reality, an LCC study uses VE techniques to identify all costs related to the subject (functional) area, and VE’s special contribution can be the selection of the best alternatives to be “life cycle-costed.”

LCC is the development of all significant costs of acquiring, owning, and using an item, a system, or a service over a specified length of time. LCC is a method used to compare and evaluate the total costs of competing solutions to satisfy identical functions based on the anticipated life of the facility or product to be acquired. In performing a value study, an LCC analysis is performed in the development phase of the value engineering job plan to determine the least costly alternative.

The value of an item includes not only consideration of what it costs to acquire it, but also the cost to use it or the cost of performance to the buyer for as long as the item is needed. The buyer, not the seller, pays the life cycle costs and therefore must determine value. One measure of value to the buyer is the calculated total cost of ownership.

Costs of repair, operations, preventive maintenance, logistic support, utilities, depreci­ation, and replacement, in addition to capital cost, all reflect on the total value of a product to a consumer. Calculation of the LCC for each alternative during performance of a value study is a way to judge whether product quality is being maintained in sufficient degree to prevent degradation of reliability, performance, and maintainability.

Life cycle cost analysis requires the knowledge of several economic concepts. One of these is the concept of equivalent costs in relation to time. Equivalent costs are typically developed by equating all costs to a common time baseline using interest rates to adjust for variable expenditure years. One must also hold the economic conditions constant while the cost consequences of each alternative are being developed. That is, the same economic factors are applied to each alternative using a uniform methodology.

A cost model is a diagrammatic form of a cost estimate. It is used as a tool in the VE process to provide increased visibility of the cost of the various elements of a system or an item, to aid in identifying the item’s subelements most suitable for cost reduction attention, and to establish cost targets for comparison of alternative approaches. It also helps define the worth of an element.

A cost model is an expression of the cost distribution associated with a specific item, product, or system. In industry, it is often referred to as a work breakdown structure. A cost model is developed by first identifying assembly, subassembly, and major compo­nent elements or centers of work. From this, the model can be expanded to include a parts breakdown at more minute levels, as necessary. Next, the costs are developed (actual, estimated, or budgeted) for each of the above categories. These become the cost elements of the model and can be viewed as the cost building blocks of cost buildup from successive levels.

Shown in Fig. 10.3 are five common categories of cost for a government construction program. Some additional items that should be considered, particularly for a commercial project, include cost of land, financing charges, building permits, and taxes.

10.5 WORTH MODEL

The same form of model used to distribute cost of a system can be used to allocate worth. The cost model and the worth model should be identical in format. The procedures to follow in creating a worth model are as follows:

1. First, the VE team determines the necessary functions to be performed by each ele­ment of work at the lowest level of activity of the cost model.

2. The worth of each of these functions is determined as explained in the job plan.

Partition

drawings

Design changes

FIGURE 10.3 Cost model for construction program.

3. The worth of all functions for each cost element is totaled and becomes the worth for that element.

4. The sum of the worth of all cost elements becomes the worth of the corresponding cost element at the next higher level.

Thus, the VE team develops the minimum costs it believes are possible for each block of the cost model. The result is a cost model representing minimum costs. These costs become targets to be compared with costs as reflected by the best estimates available. Cost blocks having the greatest differences between target and estimated costs are then selected for VE study.

(H. G. Tufty, Compendium on Value Engineering, Indo-American Society, Bombay, 1989.)