LIFE CYCLE COST (LCC)

Life Cycle Cost Analysis

Identify an appropriate methodology for comparing the two systems and prepare a working spreadsheet showing the comparative costs of the two systems, discounted over the lifetimes of the systems?

Life cycle costing (LCC) is defined as: “A method of cost analysis that estimates the cost of the project over the period of time, which includes the maintenance and operating costs”.

There are several methods that can be used to evaluate these projects; let's find out which method is appropriate for comparing the two project proposals.

The payback is the one of the investment appraisal technique that is used to compare projects that may be competing for a business's investment capital. With this technique, a business manager can know when the project is going to break even; this fact enables them to select between two and more projects. Normally the project with shortest payback period is considered more important; in contrast projects with longer payback period are not considered for investment; however payback method cannot be applied in this case because both projects do not have the income stream to cover their investment costs. For this reason, such a method will not be preferred in this case study.

There are several disadvantages for using payback method; payback method ignores the timings of cash flows within the payback period, as well as ignores cash flow after the end of the payback period. Furthermore, this method also ignores the time value of money concept. Payback method is also unable to distinguish between two projects with the same payback period. This method only considers the timing of cash flow but does not account the variability of those cash flows.

Another investment appraisal technique which can be used to find out the project return is also known as Annual Rate of Return (ARR), the projects which have highest ARR is selected between the project. Because of different net funds flow, different timing of flows and different costs of investments, it is often difficult to select between alternative projects. The ARR method allows the calculation of a percent rate of return for a project. This enables simple comparison between competing projects and allows for a judgment to be made whether a project is worthy of investment. .

We cannot apply ARR method to calculate the feasibility of both projects because profit from both project are not stated in this case, although there are several disadvantages of using ARR method for appraisal. Firstly, it does not consider the timing of a project, and it does not account for the size of the investment and the length of the investment.

In the Discounted Cash Flow (DCF) method of investment appraisal, the project that has the highest "real return" is chosen among the different projects. In this case, real returns means net money flows adjusted for the effects of changing the value of money over time. Inflation also plays an important part because it reduces the actual worth of ...