- Life-cycle cost analysis estimates the total financial impact of investment alternatives.
- Total costs include: purchase, financing, operation, maintenance and repair, as well as disposal.
- An analysis involves adding these costs and discounting them to their present day value.
Making the decision to invest in energy-efficiency projects is often difficult due to substantial upfront costs. Financial analysis tools such as simple payback and net present value (NPV) provide insight into when you can expect a return on your investment, but neither measures the costs and benefits of a proposed project over its entire useful life. Life-cycle cost (LCC) analysis does just that, helping you estimate the total financial impact associated with each project alternative.
Determining life-cycle costs
Life-cycle cost is the total cost of owning, operating, maintaining, and disposing of equipment or building systems over the proposed lifetime of the project. For example, if a boiler retrofit has a projected lifetime of 20 years that would be the analysis period. A number of value categories are incorporated into a life-cycle cost analysis, including:
- Initial equipment purchase and installation
- Financing—loan payments and other financing charges
- Energy costs
- Non-fuel operating, maintenance, and repair costs
- Disposal cost or residual value
- Equipment replacement costs
While the initial purchase price and financing costs are fixed, other costs can be more difficult to estimate. Calculate annual energy costs by multiplying the equipment nameplate (kW or Btu) energy rating, energy-efficiency rating, estimated operating hours, and your average electric or gas rate. Estimating operating, maintenance, and repair over the life of equipment can be challenging. A good resource is the Facility Maintenance and Repair Cost Reference from Whitestone Research. Although it is difficult to project how much it will cost to replace equipment in the future, current equipment purchase and installation costs can serve as a useful starting point.
The changing value of money
Money changes value over time. To compare cash flows that occur at different times during the life of a project, they have to be made time-equivalent. An LCC analysis converts future cash flows to their present value by discounting them with an interest rate. The interest rate used for discounting reflects the minimum rate of return that the investor hopes to achieve. The discount factor used in federal energy projects is published annually by the Federal Energy Management Program. This can serve as a base discount factor for a life-cycle cost analysis. If financing is part of the project, the loan interest rate can be used as the discount factor.
Life-cycle cost calculation
After identifying all costs by year and discounting them to their present day value, they are added to determine total life-cycle costs:
The following table provides a simple example of the concept of LCC analysis. Two retrofit options are considered. Option A is a standard efficiency model, while Option B is a higher efficiency alternative. The initial cost and financing costs of Option B are higher. Both options assume a loan financing rate of 7 percent and subsequent partial system equipment replacement in five years. The initial costs are given in base value (the time of the initial investment) while future costs are discounted to present value using a discount rate of 8 percent.
|Value Category||Option A||Option B|
|Base Value||Present Value||Base Value||Present Value|
Since the total present value LCC of Option B ($95,124) is less than that of Option A ($107,417), the energy-efficient option would be preferred in this case.
Energy-efficiency investments typically involve a great deal of uncertainty about their costs and potential savings. An LCC analysis comparing different investment alternatives can increase the likelihood of choosing the project that saves the most money in the long run.
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