Introduction to Asset Life Cycle Cost

winda.nurcahyo@uii.ac.id

Asset Life Cycle Management

 39 Subjects and 6 Groups in the Model

Life-Cycle Management
Life Cycle Management is a business management
approach that can be used by all types of business (and
other organizations) in order to improve their
sustainability performance.
 Value of Asset to Organisation
• Asset management does
not focus on the asset itself,
but on the value that the
asset can provide to the
organization.

• To realize the value from

asset, a life cycle
management approach can
be used.

Asset Life Cycle

 Planning
• Planning is the first stage of the asset life cycle. This stage establishes
and verifies asset requirements. Establishment of asset requirements is
based on evaluation of the existing assets and their potential to meet
service delivery needs. Identification of management strategies is
required in order to include and analyze the need for an asset.
Throughout all stages of planning, it is crucial to make sure that the
ongoing development adds value to the organization.
• If the company uses effectively planning in all asset management cycle
stages, it will help in:
– assessing the practical sufficiency of existing assets
– ensuring resources are available when necessary
– recognizing excess or under-performing assets
– estimating options for asset provision and funding asset acquisition
– ensuring assets are maintained and liable
– The progress of an asset management project as component of the organization’s planning
procedures gives the most excellent means of delivering value-added asset management.

Acquisition
• Taking the best decision on choosing the best option can only be
made after defining the cost and the requirements. The choice will
be the phase of further planning, the acquisition planning. The
acquisition planning includes activities involved in purchasing an
asset with the aim of ensuring cost effective acquisition. This covers
activities such as designing and procuring an asset. Appropriate
application of these activities guarantees that the asset is fit for
use.

• Initially, the organization should decide whether the asset will be

perpetually bought or built. Next, establish a budgeting for asset
acquisition along with a time frame for its acquisition and a
purchasing requirement. A practical budget and cash flow should be
put as deficient funds or otherwise project management can put at
risk the process of asset acquisition. Whenever these requirements
are met, a project team should run the process to make sure that all
acquisition process activities will be completed to meet service
delivery and other organization objectives.
Operation and Maintenance
• The operation and maintenance stage indicates
the application and management of an asset,
including maintenance, with the aim of delivering
services. The plan of asset management should
have a high focus on asset maintenance issues.
Long lived assets, in the majority of public sector
assets, especially roads and buildings require
particular maintenance during their life cycle.

• Throughout this time, the asset should be focus

to appropriate maintenance, monitoring and
potential improvement to overpass any
adjustment in operational requirement.

Disposal
• When an asset reaches its end of a useful life, it can be treated as a
surplus, or otherwise is considered as an underperforming asset.
Disposal should be treated in the perspective of the effects of the
decision on service delivery and any departmental responsibilities.
A special focus should be placed on cultural heritage where there
are detailed requirements that organization should take into
consideration. If in the near future an asset is to be disposed, in
order that statutory maintenance to be taken, the maintenance
strategy should be properly adjusted.

• Any organization, in either public or private sector, will need to deal

with asset handling. Recognizing asset’s value, future value and
costs are essential, therefore developing a strategic asset
management plan is highly preferred and required. Such a strategic
asset management plan would enable an effective and well-
organized asset and deliver services.
Activity Based Costing (ABC)
• Activity-based costing (ABC) is an accounting
method that identifies the activities that a firm
performs and then assigns indirect costs to products.
An activity-based costing (ABC) system recognizes the
relationship between costs, activities and products,
and through this relationship, it assigns indirect costs
to products less arbitrarily than traditional methods.
• In Delivering Asset Life-Cycle, hundreds or perhaps
thousands of activities occurs from the planning until
the disposal stage of the asset.
• Refer to the ABC, these activities generates cost.
• The cost to deliver the asset life-cycle is “Life-Cycle
Cost” (LCC)
Life-Cycle Cost (LCC)
• The total cost throughout its life including planning, design, acquisition
and support costs and any other costs directly attributable to owning or
using the asset.
• Life Cycle Cost (LCC) of an item represents the total cost of its ownership,
and includes all the cots that will be incurred during the life of the item to
acquire it, operate it, support it and finally dispose it. Life Cycle Costing
adds all the costs over their life period and enables an evaluation on a
common basis for the specified period (usually discounted costs are used).
• This enables decisions on acquisition, maintenance, refurbishment or
disposal to be made in the light of full cost implications. In essence, Life
Cycle Costing is a means of estimating all the costs involved in procuring,
operating, maintaining and ultimately disposing a product throughout its
life.
• Life cycle costing is different from traditional cost accounting system which
reports cost object profitability on a calendar basis (i.e. monthly, quarterly
and annually) whereas life cycle costing involves tracing costs and
revenues of a cost object (i.e. product, project etc.) over several calendar
periods (i.e. projected life of the cost object).

Elements of LCC :
• Acquisition costs (or design and development costs).
• Operating costs:
– Cost of failures
– Cost of repairs
– Cost for spares
– Downtime costs
– Loss of production
• Maintenance costs:
– Cost of corrective maintenance
– Cost of preventive maintenance
– Cost for predictive maintenance
• Disposal costs.
LCC formula (1) :
• Ebeling (2010)

Assumption:
• Ebeling (2010) has proposed assumptions in
association with the application of his LCC model.
These assumptions are:
1. The component replaced is as good as new
2. All operating units are identical and obtained at the same
time
3. Constant annual operating requirement
4. The system is in steady state
5. No preventive maintenance is undertaken during the
operational period of unit
6. No failures occur in standby, perfect switching with
insignificant down time.
LCC formula (2) :
• LCC in Cahyo (2016):

Introduced Cost Elements

New LCC

• The new introduced LCC is only for 1 year.

• However, the asset life cycle is multi-years.
• It is important to consider the value of money in the LCC
• Engineering Economics can be applied.

Engineering Economics for LCC

• Winda Nur Cahyo, S.T., M.T., Ph.D

• winda.nurcahyo@uii.ac.id
Engineering Economy
• It deals with the concepts and techniques of
analysis useful in evaluating the worth of
systems, products, and services in relation to
their costs
• It is used to answer many different questions
– Which engineering projects are worthwhile?
• Has the mining or petroleum engineer shown that the
mineral or oil deposits is worth developing?
– Which engineering projects should have a higher
priority?
• Has the industrial engineer shown which factory
improvement projects should be funded with the available
dollars?
– How should the engineering project be designed?
• Has civil or mechanical engineer chosen the best thickness
for insulation?
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Basic Concepts
• Cash flow
• Interest Rate and Time value of money
• Equivalence technique

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 Cash Flow
• Engineering projects generally have economic
consequences that occur over an extended period of
time
– For example, if an expensive piece of machinery is installed
in a plant were brought on credit, the simple process of
paying for it may take several years
– The resulting favorable consequences may last as long as
the equipment performs its useful function
• Each project is described as cash receipts or
disbursements (expenses) at different points in time

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Categories of Cash Flows

• The expenses and receipts due to engineering
projects usually fall into one of the following
categories:
– First cost: expense to build or to buy and install
– Operations and maintenance (O&M): annual expense,
such as electricity, labor, and minor repairs
– Salvage value: receipt at project termination for sale or
transfer of the equipment (can be a salvage cost)
– Revenues: annual receipts due to sale of products or
services
– Overhaul: major capital expenditure that occurs during the
asset’s life

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Cash Flow diagrams
• The costs and benefits of engineering projects
over time are summarized on a cash flow diagram
(CFD). Specifically, CFD illustrates the size, sign,
and timing of individual cash flows, and forms the
basis for engineering economic analysis
• A CFD is created by first drawing a segmented
time-based horizontal line, divided into
appropriate time unit. Each time when there is a
cash flow, a vertical arrow is added − pointing
down for costs and up for revenues or benefits.
The cost flows are drawn to relative scale

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Drawing a Cash Flow Diagram

• In a cash flow diagram (CFD) the end of period t is the
same as the beginning of period (t+1)
• Beginning of period cash flows are: rent, lease, and
insurance payments
• End-of-period cash flows are: O&M, salvages, revenues,
overhauls
• The choice of time 0 is arbitrary. It can be when a project
is analyzed, when funding is approved, or when
construction begins
• One person’s cash outflow (represented as a negative
value) is another person’s inflow (represented as a
positive value)
• It is better to show two or more cash flows occurring in
the same year individually so that there is a clear
connection from the problem statement to each cash flow
in the diagram

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An Example of Cash Flow Diagram
• A man borrowed $1,000 from a bank at 8%
interest. Two end-of-year payments: at the end of
the first year, he will repay half of the $1000
principal plus the interest that is due. At the end
of the second year, he will repay the remaining
half plus the interest for the second year.
• Cash flow for this problem is:
End of year Cash flow
0 +$1000
1 -$580 (-$500 - $80)
2 -$540 (-$500 - $40)

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Cash Flow Diagram

$1,000

1 2

$540
$580

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Time Value of Money

• Money has value

– Money can be leased or rented
– The payment is called interest
– If you put $100 in a bank at 9% interest for one time period
you will receive back your original $100 plus $9

Original amount to be returned = $100

Interest to be returned = $100 x .09 = $9

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Compound Interest
• Interest that is computed on the original
unpaid debt and the unpaid interest
• Compound interest is most commonly used
in practice
• Total interest earned = In = P (1+i)n - P
– Where,
• P – present sum of money
• i – interest rate
• n – number of periods (years)
I2 = $100 x (1+.09)2 - $100 = $18.81
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Future Value of a Loan With Compound
Interest
• Amount of money due at the end of a loan
– F = P(1+i)1(1+i)2…..(1+i)n or F = P (1 + i)n
– Where,
• F = future value and P = present value
• Referring to slide #10, i = 9%, P = $100 and say n= 2.
Determine the value of F.

F = $100 (1 + .09)2 = $118.81

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Notation for
Calculating a Future Value

• Formula:
F=P(1+i)n is the
single payment compound amount factor.
• Functional notation:
F=P(F/P,i,n) F=5000(F/P,6%,10)
• F =P(F/P) which is dimensionally correct.

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Notation for
Calculating a Present Value
• P=F(1/(1+i))n=F(1+i)-n is the
single payment present worth factor.
• Functional notation:
P=F(P/F,i,n) P=5000(P/F,6%,10)
Interpretation of (P/F, i, n): a present sum P,
given a future sum, F, n interest periods hence
at an interest rate i per interest period

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Spreadsheet Function
P = PV(i,N,A,F,Type)
F = FV(i,N,A,P,Type)
i = RATE(N,A,P,F,Type,guess)
Where, i = interest rate, N = number of interest
periods, A = uniform amount, P = present sum of
money, F = future sum of money, Type = 0 means
end-of-period cash payments, Type = 1 means
beginning-of-period payments, guess is a guess
value of the interest rate

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Equivalence
• Relative attractiveness of different alternatives
can be judged by using the technique of
equivalence
• We use comparable equivalent values of
alternatives to judge the relative
attractiveness of the given alternatives
• Equivalence is dependent on interest rate
• Compound Interest formulas can be used to
facilitate equivalence computations

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Technique of Equivalence

• Determine a single equivalent value at a

point in time for plan 1.
• Determine a single equivalent value at a
point in time for plan 2.
Both at the same interest rate and at the same time point.

•Judge the relative attractiveness of the

two alternatives from the comparable
equivalent values.
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Given the choice of these two plans which would
you choose?
Year Plan 1 Plan 2
0 $5,000
1 $1,000
2 $1,000
3 $1,000
4 $1,000
5 $1,000
Total $5,000 $5,000

To make a choice the cash flows must be altered so a comparison may be made.
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Resolving Cash Flows to Equivalent Present Values

• P = $1,000(P|A,10%,5)
• P = $1,000(3.791) = $3,791

• P = $5,000
• Alternative 2 is better than
alternative 1 since
alternative 2 has a greater
present value

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An Example of Future Value
• Example: If $500 were deposited in a bank
savings account, how much would be in the
account three years hence if the bank paid
6% interest compounded annually?
• Given P = 500, i = 6%, n = 3, use F =
FV(6%,3,,500,0) = -595.91
• Note that the spreadsheet gives a negative
number to find equivalent of P. If we find P
using F = -$595.91, we get P = 500.

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An Example of Present Value

• Example 3-5: If you wished to have $800 in
a savings account at the end of four years,
and 5% interest we paid annually, how
much should you put into the savings
account?
• n = 4, F = $800, i = 5%, P = ?
• P = PV(5%,4,,800,0) = -$658.16
• You should use P = $658.16

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Present Worth Analysis
• A construction enterprise is investigating the
purchase of a new dump truck. Interest rate is 9%.
The cash flow for the dump truck are as follows:
• First cost = $50,000, annual operating cost = $2000,
annual income = $9,000, salvage value is $10,000, life
= 10 years. Is this investment worth undertaking?
• P = $50,000, A = annual net income = $9,000 - $2,000
= $7,000, S = 10,000, n = 10.
• Evaluate net present worth = present worth of
benefits – present worth of costs

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Present Worth Analysis

• Present worth of benefits = $9,000(P|A,9%,10) =
$9,000(6.418) = $57,762
• Present worth of costs = $50,000 +
$2,000(P|A,9%,10) - $10,000(P|F,9%,10)= $50,000 +
$2,000(6..418) - $10,000(.4224) = $58,612
• Net present worth = $57,762 - $58,612 < 0  do not
invest
• What should be the minimum annual benefit for
making it a worthy of investment at 9% rate of
return?

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Present Worth Analysis
• Present worth of benefits = A(P|A,9%,10) =
A(6.418)
• Present worth of costs = $50,000 +
$2,000(P|A,9%,10) - $10,000(P|F,9%,10)=
$50,000 + $2,000(6..418) - $10,000(.4224) =
$58,612
• A(6.418) = $58,612  A = $58,612/6.418 =
$9,312.44

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