1. LIFE CYCLE COST DEFINITIONS
Life cycle costs are summations of cost estimates from inception to disposal for both
equipment andprojects as determined by an analytical study and estimate of total costs
experienced during their life. Theobjective of LCC analysis is to choose the most cost
effective approach from a series of alternatives so theleast long term cost of ownership is
achieved.LCC analysis helps engineers justify equipment and process selection based on
total costs rather than theinitial purchase price. Usually the cost of operation, maintenance,
and disposal costs exceed all other costsmany times over. Life cycle costs are the total costs
estimated to be incurred in the design, development,production, operation, maintenance,
support, and final disposition of a major system over its anticipateduseful life span (DOE
1995). The best balance among cost elements is achieved when the total LCC isminimized
(Landers 1996). As with most engineering tools, LCC provides best results when both art
andscience are merged with good judgment.
What is Life Cycle Costing?
The Life Cycle Cost (LCC) of an asset is defined as:
“The total cost throughout its life including planning, design, acquisition and support
costs andany other costs directly attributable to owning or using the asset".Life Cycle
Costing adds all the costs of alternatives over their life period and enables an evaluation ona
common basis for the period of interest (usually using discounted costs). This enables
decisions onacquisition, maintenance, refurbishment or disposal to be made in the light of
full cost implications.
Why use LCC
Procurement costs are widely used as the primary (and sometimes only) criteria for
equipment or systemselection. This single purpose criteria is simple to use but often results
in bad financial decisions.Procurement costs tell only one part of the story—most frequently
the story is so simple, the results may bedamaging to the financial well-being of the business
enterprise. Often the initial procurement costs, basedon simple rules, are so cheap they are
not affordable. Simple tools (meaning composed on only one thing)usually give simple
results (meaning insubstantial, superficial, and not to be taken seriously). Remember
theadage attributed to John Ruston: ―It’s unwise to pay too much, but it’s foolish to spend too
little‖—this isthe operating principle of LCC.End users and suppliers of equipment can use
life-cycle costs for:
Affordability studies:
Measure the impact of a system or project’s LCC on long termbudgets and operating results.
Source selection studies:
Compare estimated LCC among competing systems or suppliers ofgoods and services.
Design trade-offs:
Influence design aspects of plants and equipment that directly impactLCC.

2. Repair level analysis:
Quantify maintenance demands and costs rather than using rules of thumb such as
“…maintenance costs ought to be less than _ ? _% of the capital cost of theequipment”.
Warranty and repair costs:
Suppliers of goods and services along with end-users need to understand the cost of early
failures in equipment selection and use.
Suppliers sales strategies-can merge specific equipment grades with general
operatingexperience and end-user failure rates using LCC to sell for best benefits rather than
just sellingon the attributes of low, first cost.
1.1 Why use Life Cycle Costing?
The determination of costs is an integral part of the asset management process and is a
commonelement of many of the asset manager’s tools, particularly Economic Appraisal,
Financial Appraisal,Value Management, Risk Management and Demand Management.
In the past, comparisons of asset alternatives, whether at the concept or detailed design
level, havebeen based mainly on initial capital costs.Growing pressure to achieve better
outcomes from assets means that on-going operating andmaintenance costs must be
considered as they consume more resources over the asset’s service life.For example, the
operating costs of a hospital consume an equivalent of the capital cost every twoto three
years and can continue to do so for forty years or more. The operating costs of a schoolcan
consume the equivalent of its capital cost every four to five years and remain in service for
acentury.
Both the capital and the ongoing operating and maintenance costs must be considered
whereverasset management decisions involving costs are made. This is the Life Cycle Cost
approach.Life Cycle Costing is a process to determine the sum of all the costs associated
with an asset or partthereof, including acquisition, installation, operation, maintenance, and
refurbishment and disposal costs.It is pivotal to the asset management process as an input
to the evaluation of alternatives via
Economic Appraisal, Financial Appraisal, Value Management, Risk Management and
demandmanagement.There is an Australian Standard on Life Cycle Costing (AS4536) that
includes examples of theapplication of Life Cycle Costing in its appendices.
Usually
the only value in the life cycle cost equation which is well known and clearly identified is
procurementcost—but it’s only the tip of the iceberg. Seeing the tip of an iceberg (similar to
the obviousness of3-5Fifth International Conference on Process Plant Reliabilityprocurement
cost) does not guarantee clear and safe passage around an iceberg. Hidden, underlying,
substructures of an iceberg (similar to the bulk of other costs associated with life cycle
costing forequipment and systems) contain the hazards.

3. Life cycle cost
Life cycle cost is the total cost of ownership of machinery and equipment, including its cost
of acquisition, research and development, operation, maintenance, conversion, and/or
terminations
LCC costs have two major elements: 1) acquisition costs and 2) sustaining costs.
A& S cost are not mutually exclusive.. If you acquire equipment or processes, they always
require extra cost to sustain the acquisition
A & S cost are found by evaluating the LCC and conducting the sensitivity analysis to find
the cost drivers.
LCC concepts are resurging. LCC limitations are accepted as normal restrictions on every
engineeringtool. Usefulness has been demonstrated by passing the test of time with
practitioners who have learnedhow to minimize LCC limitations. As with all cost techniques
(and typical of all engineering tools) thelimitations can result in substantial setbacks when
judgment is not used. Here are some of the most oftencited LCC limitations:
LCC is not an exact science, everyone gets different answers and the answers are
neitherwrong nor right—only reasonable or unreasonable. LCC experts do not exist because
thesubjects are too broad and too deep.
LCC outputs are only estimates and can never be more accurate that the inputs and
theintervals used for the estimates—this is particularly true for cost-risk analysis.
LCC estimates lack accuracy. Errors in accuracy are difficult to measure as the
variancesobtained by statistical methods are often large.
LCC estimates lack accuracy. Errors in accuracy are difficult to measure as the
variancesobtained by statistical methods are often large.
LCC models operate with limited cost databases and the cost of acquiring data in the
operatingand support areas is both difficult to obtain and expensive to acquire.
LCC cost models must be calibrated to be highly useful.
LCC models require volumes of data and often only a few handfuls of data exist—and most
ofthe available data is suspect.

4. Sunk costs
Sunk costs are sums that have already been spent and can not be recovered.
The concept is important because sunk costs are irrelevant to financial decisions. Many people tend
to feel instinctively that because an investment has been made it is necessary to get a return on it.
This can lead to people rejecting one course of action in favour of another that actually generates
smaller cash flows. This can happen to business, portfolio investment and personal decisions.
Suppose a hotel has calculated that their cost for providing a room is £100 per night, of which £50
covers their rental of the building (i.e. the cost of the rental divided the number of rooms) and £20
covers their other fixed costs (such as staff) and £30 covers the costs that result from having an extra
guest (e.g. electricity, laundry, food included in the price etc.)
Now suppose the market rate for hotel rooms goes down and they are only able to charge £50 per
night. The hotel is committed to remaining open. It appears that the hotel will make a £50 loss on
each night per guest so they should not accept bookings until prices rise. Of course this is wrong as
the rent and other fixed costs are already committed to and have to be paid anyway. The hotel
should accept bookings at any price it can get above £30, as these make a positive contribution.
A common mistake made by investors is reluctance to sell securities at a loss. It does not matter
what you paid for shares, if the market price has fallen you have already made that loss. It is a sunk
cost and should be forgotten about. What matters is whether the shares are worth holding or not at
the current market price. A key question is whether the shares would still be worth buying at current
prices. If not, they are probably not worth holding.
Sunk Costs:
Sunk costs are costs that were incurred in the past. Committed costs are costs that will
occur in the future, but that cannot be changed. As a practical matter, sunk costs and
committed costs are equivalent with respect to their decision-relevance; neither is relevant
with respect to any decision, because neither can be changed. Sometimes, accountants use
the term ―sunk costs‖ to encompass committed costs as well.
Experiments have been conducted that identify situations in which individuals, including
professional managers, incorporate sunk costs in their decisions. One common example
from business is that a manager will often continue to support a project that the manager
initiated, long after any objective examination of the project seems to indicate that the best
course of action is to abandon it. A possible explanation for why managers exhibit this
behavior is that there may be negative repercussions to poor decisions, and the manager
might prefer to attempt to make the project look successful, than to admit to a mistake.
Some of us seem inclined to consider sunk costs in many personal situations, even though
economic theory is clear that it is irrational to do so. For example, if you have purchased a
nonrefundable ticket to a concert, and you are feeling ill, you might attend the concert
anyway because you do not want the ticket to go to waste. However, the money spent to buy
the ticket is sunk, and the cost of the ticket is entirely irrelevant, whether it cost $5 or $100.
The only relevant consideration is whether you would derive more pleasure from attending
the concert or staying home on the evening of the concert.

5. Here is another example. Consider a student who is between her junior and senior year in
college, deciding whether to complete her degree. From a financial point of view (ignoring
nonfinancial factors) her situation is as follows. She has paid for three years of tuition. She
can pay for one more year of tuition and earn her degree, or she can drop out of school. If
her market value is greater with the degree than without the degree, then her decision
should depend on the cost of tuition for next year and the opportunity cost of lost earnings
related to one more year of school, on the one hand; and the increased earnings throughout
her career that are made possible by having a college degree, on the other hand. In making
this comparison, the tuition paid for her first three years is a sunk cost, and it is entirely
irrelevant to her decision. In fact, consider three individuals who all face this same decision,
but one paid $24,000 for three years of in-state tuition, one paid $48,000 for out-of-state
tuition, and one paid nothing because she had a scholarship for three years. Now assume
that the student who paid out-of-state tuition qualifies for in-state tuition for her last year, and
the student who had the three-year scholarship now must pay in-state tuition for her last
year. Although these three students have paid significantly different amounts for three years
of college ($0, $24,000 and $48,000), all of those expenditures are sunk and irrelevant, and
they all face exactly the same decision with respect to whether to attend one more year to
complete their degrees. It would be wrong to reason that the student who paid $48,000
should be more likely to stay and finish, than the student who had the scholarship.
Relevant costs
Relevant costs are costs that change with respect to a particular decision. Sunk costs are
never relevant. Future costs may or may not be relevant. If the future costs are going to be
incurred regardless of the decision that is made, those costs are not relevant. Committed
costs are future costs that are not relevant. Even if the future costs are not committed, if we
anticipate incurring those costs regardless of the decision that we make, those costs are not
relevant. The only costs that are relevant are those that differ as between the alternatives
being considered.
Including sunk costs in a decision can lead to a poor choice. However, including future
irrelevant costs generally will not lead to a poor choice; it will only complicate the analysis.
For example, if I am deciding whether to buy a Toyota Camry or a Subaru Legacy, and if my
auto insurance will be the same no matter which car I buy, my consideration of insurance
costs will not affect my decision, although it will slightly complicate the analysis.
Relevant costs
A relevant cost is a cost that only relates to a specific management decision, and which will
change in the future as the result of that decision.
The relevant cost concept is extremely useful for eliminating extraneous information from a
particular decision-making process. Also, by eliminating irrelevant costs from a decision,
management is prevented from focusing on information that might otherwise affect its
decision.
For example, the Archaic Book Company (ABC) is considering purchasing a printing press
for its medieval book division. If ABC buys the press, it will eliminate 10 scribes who have
been copying the books by hand. The wages of these scribes are relevant costs, since they

6. will be eliminated in the future if management buys the printing press. However, the cost of
corporate overhead is not a relevant cost, since it will not change as a result of this decision.
What is a differential cost?
Differential cost is the difference between the cost of two alternative decisions, or of a
change in output levels. Here are two examples:
Example of alternative decisions. If you have a decision to run a fully automated operation
that produces 100,000 widgets per year at a cost of $1,200,000, or of using direct labor to
manually produce the same number of widgets for $1,400,000, then the differential cost
between the two alternatives is $200,000.
Example of change in output. A work center can produce 10,000 widgets for $29,000 or
15,000 widgets for $40,000. The differential cost of the additional 5,000 widgets is $11,000.
.In essence, you can line up the revenues and expenses from one decision next to similar
information for the alternative decision, and the difference between all line items in the two
columns is the differential cost.
A differential cost can be a variable cost, a fixed cost, or a mix of the two – there is no
differentiation between these types of costs, since the emphasis is on the gross difference
between the costs of the alternatives or change in output.
Since a differential cost is only used for management decision making, there is no
accounting entry for it.