The College of Estate Management 2010 Paper 1116V9-0

Life cycle costing

Contents
Aims Learning outcomes 1. Introduction 2. Value for money 3. Value engineering and life cycle costing 4. Private Finance Initiative/Public-Private Partnerships and life cycle costing 5. Terminology and definitions 6. Life cycle costing in use 7. Life cycle cost categories 7.1 Construction costs 7.2 Maintenance costs 7.3 Operation costs 7.4 Occupancy costs 7.5 End of life costs 7.6 Taxation, grants and subsidies 8. The life of a building 8.1 Physical or structural life 8.2 Economic life 8.3 Operating life 8.4 Functional life 9. Stages in life cycle costing 10. Discount rates 10.1 Interest 10.2 Allowing for inflation 11. Use of discount tables 11.1 Use of present value of 1 table 11.2 Use of years purchase table (Continued)

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12. Examples of life cycle costing calculations 13. Annual sinking funds and annual equivalents 14. Sources of data 14.1 Cost data 14.2 Maintenance data 15. Risks and uncertainty 15.1 Operating life of a building 15.2 Assessment of component life 15.3 Extent of repairs 15.4 Reliability of component life data 15.5 Changes in technology, fashion and availability of spare parts 15.6 Building in use 15.7 Assessment of future costs 15.8 Reliability of maintenance cost information 15.9 Escalation of labour or material costs 15.10 Energy costs 15.11 Discount rate 15.12 Impact of risks and uncertainties 16. Sensitivity analysis 17. Report for client 18. Summary 19. Further reading Bibliography Appendix A: Discount tables Appendix B: Answers to tasks Appendix C: Answers to self-assessment questions Appendix D: Extract from BSI (2008) Standardized Method of Life Cycle Costing for Construction Procurement, A Supplement to BS ISO 15686-5 Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing: Annex A: Menu of life cycle costs and whole life cycle costs, pp. 5455. Appendix E: Extract from BSI (2008) Standardized Method of Life Cycle Costing for Construction Procurement, A Supplement to BS ISO 15686-5 Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing: Annex D: Worked examples, pp. 6063. Appendix F: BCIS (2006) Life Expectancy of Building Components: A Practical Guide to Surveyors Experiences of Buildings in Use, pp. 2, 11, 22, 221, 327, 340. Appendix G: Building Performance Group Ltd (2001) Building Services Component Life Manual, London: Blackwell Science Ltd, pp. xvi, xvii, 53, 55. Appendix H: BCIS (2009) Building Maintenance Price Book, pp. 5, 58, 182, 247.

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Aims
The aim of this paper is to introduce you to the importance of considering not only initial costs of construction but also the future costs associated with owning and running a property after construction. You will be introduced to the methods used to compare the life cycle costs of different design options. This in turn allows decisions to be made at the design stage of a project so that the clients future needs are met in relation to initial and future costs.

Learning outcomes
After studying this paper you should be able to:
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understand and discuss the meaning of value for money; describe all costs associated with the whole life of a building; recognise and explain the four different terms used to describe what is meant by the life of a building; undertake life cycle costing (LCC) exercises associated with buildings using discount tables as required; understand the use of annual sinking funds and annual equivalents; discuss and appreciate the problems associated with the assessment of life cycle costs; discuss and appreciate prediction errors within life cycle cost calculations and demonstrate use of sensitivity analysis.

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1 Introduction
The cost of a building does not stop when the final bill has been paid to the contractor on completion of the construction work. In fact, costs associated with owning and running a property begin once construction work is completed and continue throughout the life of the building. Over a buildings life these costs usually far exceed the initial cost of construction. Figure 1 below provides an illustration.
FIGURE 1

Using the Building Cost Information Services Building Running Costs Online service life cycle costing calculator (BCIS 2009b), a comparison can be made between initial costs and future running costs.
Scenario

1,000m air-conditioned office, over a 30-year period, price level fourth quarter 2007, UK mean location. Initial cost 1,493,000 (27%) Running costs (based on current cash values) Redecoration 86,300 Fabric maintenance 344,655 Services maintenance 644,920 Cleaning 465,000 Utilities (fuel, water, drainage) 1,245,000 Administration costs 1,172,340 Running costs total 3,958,215 (73%) TOTAL (based on current prices) 5,451,215 (100%) Based on current prices at fourth quarter 2007, over a 30-year period, the running costs are 2.7 times the initial cost of construction. Notes:
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The current cash values are based on current prices, and no adjustment is made for inflation or interest received through investments. The calculator allows for adjustment to required base dates, and prices are adjusted automatically from fourth quarter 2007 using indices.

The above can be represented graphically:

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2 Value for money

In all walks of life, people want to achieve value for money whenever they make a purchase, and this is no different for clients who instruct the construction of a building. However, what is value for money and how is it measured? Value for money has different meanings for different clients and it does not necessarily mean least cost. For a client, value for money means providing a building which meets his requirements in terms of:
z z z z z z z z z z z z z

cost quality time initial, design and construction period quantity size of building achievable for given amount of money adaptability appearance comfort utility or functional performance future running and maintenance costs disruption time and costs incurred while carrying out future maintenance market value sustainability revenue earning value.

Each client will prioritise the above differently, depending on the type of building and its future use. Table 1 illustrates some of the criteria which might be considered to be important in relation to initial costs for different types of building. Table 2 provides a comparison for future costs.
TABLE 1

Initial costs Noncommercial building

Important criteria z Appearance

z

Commercial building

z z z z

Developer

A client may pay a large sum of money to have a decorative building erected. Even Functional utility though it may have a low market value, he may consider it good value for money because he gains personal pleasure from looking at it. Revenue earning value Revenue earning value is of high importance, but its appearance and Appearance functional utility are also important as an Functional utility attraction to customers and an aid to efficiency. The owner may be prepared to Minimum disruption pay more initially if it means less frequent when in use maintenance and thus less disruption to the operation of the property. Initial target cost Initial target costs for the developer, will depend on his prediction of the property market. However, developers are now seeing low levels of future maintenance and associated costs as a good selling point for their properties and are considering increasing initial target costs if necessary to meet demand for such buildings.

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TABLE 2

Future costs Important criteria z Value of property Noncommercial z Inconvenience building

Commercial building

z z z

A client may want to know the likely amount that will be achieved if the property were resold after works are carried out. However, if there is no intention to sell, personal pleasure and general improvement to the property will play an important part in any assessment of value for money Revenue earning value Any costs are likely to be measured against the revenue earning value of the Cost property. Invariably, disruption is Minimum disruption associated with loss of revenue and for when in use commercial buildings this will be an important consideration.

This can be further illustrated:

A client commissioning the design of a house
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May be prepared to pay a large sum of money to have a decorative and unique building which would not be reflected in its market value. However, he considers this to be good value for money because he gains personal pleasure from looking at it.

A client wanting a factory Appearance is less vital unless it is important to attract customers. Revenue-earning value of the building is vital so it must function well. Adaptability might be important. Efficiency is important so size and layout must be carefully considered. Minimum disruption will be important as this will affect productivity.

z z

Value for money can be considered and applied to refurbishment projects as well as to the construction of new buildings.

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The aim is to produce a building that gives the best value for money, taking into account both initial and user costs. However, this may not always be possible because of difficulty in obtaining money in the initial stages. One of the first problems the client has to solve is how much he can afford to spend and how the money can be raised. If it is difficult for him to raise capital, he may aim at a low initial cost, even though the user costs might be proportionately higher. In the case of a developer, his initial cost target will depend upon his prediction of the property market. In most cases, however, it will be a help to have an idea of the probable saving in initial costs of various designs, and also the effect on the user cost. This paper is going to look at a way in which initial and future running costs can be examined. By doing this, various alternative design solutions can be compared. This allows the client to make choices at the design stage which take account of not only initial cost but also future costs. Life cycle cost calculations are an attempt to price as many as possible of the factors affecting the initial and future costs of a building and to bring them into a single cost value. This cost value can then be compared with other design solutions. Other factors, such as appearance, comfort and convenience, can then be considered although these are difficult to price and depend on personal judgement. In this way, some of the aspects of value for money are considered. The more complex the structure, the more difficult it is to choose one solution from alternatives. By considering future costs, the client can be offered advice which will be useful in considering value for money criteria.

3 Value engineering and life cycle costing

BSRIA Application Guide 15/96: Value Engineering of Building Services (Hayden and Parsloe 1996: 5) provides the following typical definition for value engineering: A systematic approach to achieving the required project functions at least cost without detriment to quality, performance and reliability. Through this process, the client should achieve an increase in value. It is vitally important that the conditions contained within the above definition are recognised. Value engineering is not about simply providing the client with the cheapest option if the cheapest option does not meet the quality, performance or reliability that the client wants, then the cheapest option is not appropriate. Therefore all the factors discussed above about value for money have to be considered. Value engineering is part of the overall value management process that can be undertaken for any project. Value engineering should be carried out during the precontract stages whenever there are options to be considered. Part of the value engineering process will evaluate the cost of the options. Often this will happen during the design stages when comparison of options is required. The calculation of life cycle costs associated with a project is one of the techniques used in the value engineering process.

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4 Private Finance Initiative/Public-Private Partnerships and life cycle costing

Private Finance Initiative (PFI) arrangements are used by local and central governments for some of their building projects through Public-Private Partnerships (PPP), resulting in the involvement of the private sector in public sector projects such as schools and hospitals. These projects are different from those using traditional building contracts, where the client pays for the project on completion and becomes responsible for all future running costs. Instead, under a PFI/PPP arrangement, the contractor retains responsibility for the running costs of a building for an agreed period of time. For a school, for example, this might be 25 years. During this period, the contractor is paid for the initial construction and subsequent running costs at an agreed amount per annum, thus spreading the cost of initial construction. Then, at the end of the 25 years, the contractor rectifies any defects, undertakes agreed maintenance, etc., so that the school is handed over to the local government authority in a pre-determined condition. The authority then takes over responsibility for all future running costs. Often, the contractor is also responsible for aspects of the design of the project. The contractor will therefore be concerned with the optimum design and specification with regard to initial construction and also future running costs, to ensure that the payments received during the time when they are responsible for the building will be sufficient to meet the costs incurred. If this is achieved, then the project will be regarded as a financial success. The calculation of life cycle costs is therefore an important part of the design development of the project.

5 Terminology and definitions

Various terms are used to describe the total cost of a building during its life:
z z z

whole life cost life cycle cost cost in use.

You will find each of the above used in different books, sometimes interchangeably. No matter which term is used, the principles and methods used are the same. However, in this paper, the definitions used are from the British Standards Institutes (BSI) BS ISO 15686-5:2008: Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing (BSI 2008a).

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A supplement to BS ISO 15686-5, Standardized Method of Life Cycle Costing for Construction Procurement (BSI 2008b), includes the following: Life cycle cost (LCC) is cost of an asset, or its parts throughout its life cycle, while fulfilling the performance requirements. (BS ISO 15685-5, 3.1.1.7) Whole life cost (WLC) is all significant and relevant initial and future costs and benefits of an asset, throughout its life cycle, while fulfilling the performance requirements. (BS ISO 15685-5, 3.1.1.14) Life cycle costing is methodology for the systematic economic evaluation of life cycle costs over a period of analysis, as defined in the agreed scope. (BS ISO 15685-5, 3.1.1.8) Whole life costing is methodology for the systematic economic consideration of all whole life costs and benefits over a period of analysis, as defined in the agreed scope. (BS ISO 15685-5, 3.1.1.15) Agreed scope: In a life cycle or whole life costing calculation, there are many factors and costs which could be incorporated. However, it is essential that the possibilities are discussed with the client, as it will not always be appropriate or necessary to include all of them. By deciding what to include and exclude, the agreed scope of the calculation is established.
FIGURE 2

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So, what is the difference between life cycle costing and whole life costing? The difference is simply that whole life costings include life cycle costs plus nonconstruction costs such as site costs, finance costs, rental costs, etc. and also income such as income from sales, loss of income, etc. Whole life costs therefore relate to the overall development, whereas life cycle costs relate to the building only. Figure 2 illustrates the relationship between whole life costs and life cycle costs, and gives some examples of the costs and income associated with whole life costs. In relation to the above, the following should be noted:
z

Site costs will include the cost of purchasing the land or existing buildings, together with associated legal fees. If the site is purchased near the date of development, the cost will be the actual amount paid. If the site has been purchased some time before, the cost should be its market value at the start of development, and the legal costs would not be included. Finance costs will be the interest or other financial charges on the cost of site purchase and on the monies required to pay for the construction of the building. Rental costs will include legal and agents fees on the initial letting where the property is not owner-occupied; the cost of letting and reletting where necessary; as well as the cost of ensuring the tenant is abiding by the clauses in his lease. Accountants who deal with payments, etc. may also be included in this item. Some properties are subject to a ground rent which is a cost to the owner-occupier or lessor. Government grants and tax allowances. Tax allowances and building grants that may be available on some initial and future costs for companies and other organisations should be included in the whole life cost calculations. These are not covered in detail in this paper; you should seek expert advice as to whether they should be taken into consideration on specific projects.

In this paper, we will be focusing on the building, and will therefore be looking in more detail at life cycle costing. It should be remembered, however, that the techniques used for preparing life cycle costs are the same as those used for whole life costing.

6 Life cycle costing in use

Life cycle costing can be used for a number of purposes.
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To compare total costs of alternative design options of components over an agreed period of time. To compare alternatives for whole buildings:
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two different designs. These might be different designs using similar techniques, or might be a comparison between different constructional techniques, e.g. traditional and prefabricated construction; refurbish or rebuild (on current or new site); refurbish existing or move to an alternative building; extend or adapt existing building.

{ { { z

To establish the most cost-effective programme for maintenance and replacement work. To provide a cash flow prediction over an agreed period of time. This also can be for an individual component of a building or for the whole building.

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(Another use of life cycle costing is to calculate total costs of other assets, such as contractors plant, over an agreed period of time. Again, the techniques below would be used for this, but examples are not included here.) Invariably, life cycle cost information is being prepared for a client. The type and purpose of the LCC information prepared will depend on the stage of the project and the clients requirements. LCC can be carried out during the very early stages of a project during project appraisal. By looking at the costs over the life of a project, it enables: the client or property owner to make informed investment decisions regarding which project option is viable, sustainable and represents best value (this may be part of a wider whole life costing or sustainability and environmental assessment). Life cycle costing can influence whether or not, finally, to commit to construction (BSI 2008b: 22). At this stage, little information would be available, so only a budget LCC plan could be produced. This would be for the whole building, and would possibly be based on a cost/m gross internal floor area (GIFA). The design stage of the project will affect the amount of information that is available. As with pre-contract cost control of a building project, the more design information that is available, the more detailed the LCC plan can become. Initially, the architect will be thinking about the project in broad terms. As the architect develops his thoughts, he will be thinking perhaps in terms of elements of the building, e.g. options for the roof will it be a flat or a pitched roof? These options would allow a LCC comparison of the roof element. Later, having opted for a pitched roof, a more detailed LCC can be carried out so that the roof is split up into the sub-elements. This would consider, for example, the options for roof coverings, roof drainage, rooflights, etc. As with pre-contract cost control, cost targets can be set for LCC, and these will be monitored as the design develops and the LCC becomes more detailed. By carrying out life cycle costings, choices can be made not only based on the initial cost, but also taking account of the future costs of the element or sub-element. Prior to handover of the completed building, the LCC plan is used to prepare a costin-use budget which will be used by the client in financial planning for future maintenance costs. The client can also receive advice throughout the buildings life. Actual costs incurred can be monitored against the budget and reported upon, allowing appropriate action to be taken if required. Also, if the client wants information regarding options for altering or adapting the existing building, or even moving to another building, then life cycle costings of these options can be prepared. At the end of the planned life of the building, LCC can be a valuable tool to help to establish the financial implications involved in extending the use of the building, while comparing this with other options available to the client such as moving to an alternative building.

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7 Life cycle cost categories

Life cycle costs include many items, which may be classified in various ways. One method is given in Figure 3, which illustrates some of the costs associated with each category.
FIGURE 3

7.1 Construction costs

Construction costs are divided into two categories:
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Construction works costs incorporating cost of:

{ { { {

building works and services external works furniture, fittings and equipment which will be maintained by the client specialist contractors and artists.

Other construction-related costs costs that are incurred in relation to the initial construction, but which will not incur future life cycle costs for the client. These therefore include such items as:
{ {

site-enabling works such as demolition, site clearance, land remediation; consultancy fees for the design team generally architect, services consultants, structural engineers and quantity surveyors;

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{ {

planning and Building Regulation fees; roads which will be adopted, and therefore will not be subject to future maintenance by the client; furniture, fittings and equipment which will be maintained by the occupier or user of the building.

7.2 Maintenance costs

Maintenance will include any work undertaken to prolong the life of a building or part thereof. The following diagram illustrates the typical distribution of maintenance expenditure in a modern air-conditioned office building. This shows that 66% of the total expenditure relates to services installations.
FIGURE 4 Typical distribution of maintenance expenditure in a modern airconditioned office building

Source: Hurst R et al. (2005).

Maintenance will include:

z z z

repairs to a component (e.g. boiler) repairs to finishes (e.g. floor finishes, wall finishes, ceiling finishes) regular servicing (e.g. heating or air-conditioning installations).

When repairs are no longer viable, replacement will be required, for example:
z z

replace boiler replace roof tiles.

Other costs to be considered in the maintenance cost category are:

z

refurbishment, alteration and adaptation costs (e.g. changes in layout which can be predicted may occur several times during the life of a building); redecoration; unscheduled replacement, repairs and maintenance costs. A risk allowance should be made. This means making a financial allowance to cover costs of unplanned or emergency maintenance;

z z

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z z z

grounds maintenance; costs or income relating to disposal of replaced components and parts; inspections carried out as part of the maintenance contract.

7.3 Operation costs

Costs to be considered include:
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Cleaning costs which may be divided into different areas such as internal and external, and subdivided into elements such as windows and floors. They may include the cost of refuse removal where appropriate. Fuel costs:
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environmental energy costs, including heating, lighting, ventilation, fuel and power communication energy costs, including power for lifts, escalators and conveyors other energy costs: electric and gas power for purposes other than the above, together with energy for hot water and cooking including income from renewable energy generated (i.e. income from selling energy back to national grid).

z z

Water and drainage charges. Administrative costs:

{ {

property management (e.g. maintenance manager, clerical staff, etc.) staff engaged in servicing the building (i.e those who help the building to function efficiently (caretaker, security staff, etc.)) waste management and disposal (e.g. costs associated with staff or contractors).

Insurance. Most building owners insure for fire and theft. There may also be special insurances against breakdown for lifts, boilers, sprinklers, etc. This should be identified separately and will be allocated to the appropriate installation. Rates and other local charges relating to the building.

7.4 Occupancy costs

Some clients may wish costs associated with occupancy to be included within the life cycle cost study. There is an extensive list of the types of occupancy cost which could be included. A few examples are given in Figure 3 above. The types of occupancy cost included will depend on the use of the building.

7.5 End of life costs

This category relates to costs payable and credits accruing at the end of period of analysis (BSI 2008b).

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End of life does not necessarily mean that the building will serve no future purpose and will therefore be demolished. Rather, the end of life should be regarded as the end of the study period of the analysis. At this point there may be costs involved, for example:
z z

Disposal inspections. Demolition. If this is being carried out, any costs associated with landfill, recycling or disposal must be included. Reinstatement to meet the contractual requirements. An example where this is likely to be required is in PFI projects (see Sections 4 and 15.1) where the building will have to be returned to an agreed standard of repair.

The residual value of the building and/or site can also be taken into account. There may be demolition costs at the end of a buildings life, but the value of the site should be offset against the end of life costs.

7.6 Taxation, grants and subsidies

These may affect both initial and user costs and should be taken into account when considering life cycle costs and obtaining the best value for money. Unfortunately, taxation can change very rapidly and the changes are often difficult to forecast. Taxation tends to favour low initial costs and high running costs because annual expenditure can be allowed against income. With the exception of industrial buildings, plant and machinery, and a few other types, there is no tax advantage to be gained from higher initial costs. Taxation is not covered in detail in this paper. You should seek expert advice to establish current regulations and the extent of taxation applicable, and whether they should be taken into consideration on specific projects. Grants and subsidies are also subject to variation, and are therefore not covered in detail in this paper. Expert advice should be sought in relation to this for each specific project.

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8 The life of a building

In order to calculate the life cycle cost of a building, it is necessary to establish the life of the building being looked at. There are different terms used to describe the life of a building:
z z z z

physical or structural life economic life operating life functional life.

Each of the above has a different meaning, and when carrying out life cycle costings, it is important to establish with the client which will be the most appropriate to use for the particular building being considered.

8.1 Physical or structural life

This term describes the time during which the structure is usable for any purpose normally associated with a building. In theory the physical life of a building can be extended indefinitely as long as items that deteriorate or are damaged are replaced. In practice it may be very expensive and therefore uneconomic to replace a defective part such as a concrete roof, or to repair a building badly damaged by an earthquake or fire.

8.2 Economic life

This is the length of time it is financially beneficial for the owner or, in the case of some long leases, the lessee to retain a building.

8.3 Operating life

This is the time from the initial occupation of a building to the time when it is no longer being used for any purpose. This life is often the same as the economic life, but sometimes it may be longer perhaps because the building has sentimental value to the owner, or because the owner is ignorant of the site value or the alternatives open to him.

8.4 Functional life

This is the length of time a building is used for a particular purpose. Many buildings have several functional lives for example, a cinema may be changed to a workshop. A building may become uneconomic for one purpose, but by changing the use, its economic life can be extended. Alterations may be necessary before building uses can change. When undertaking life cycle cost studies, the functional life is the period most likely to be acceptable for calculation purposes. This is the time during which the client feels confident in his and his advisers abilities to predict future events, costs, revenues, etc. Under these circumstances, the estimated market value of the property at the end of the period is likely to be the final figure in the life cycle cost calculation. If the property is leased, the end of the lease may be an appropriate completion point for the lessee. However, an option to renew a lease may make it more appropriate to consider a longer time period.

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9 Stages in life cycle costing

A number of terms are used to identify different stages in life cycle costing techniques:
z

Life cycle cost analysis. The collection and analysis of historic data connected with the actual costs of occupying a building. In order that the data can be used for management purposes, certain physical, performance and other data may be required, e.g. areas, physical condition, temperature levels. The collection and analysis of data costs money and therefore the need for this on a commercial basis must be justified. Life cycle cost management. Collecting data about other buildings or the clients own building does not in itself produce advantages to the client. Most clients wish to obtain value for money. Life cycle cost management involves planning and controlling occupancy costs throughout the clients occupancy in order to try to obtain the greatest value for the client. Life cycle cost planning. Part of life cycle cost management. It involves using life cycle cost analysis in order to predict future costs. It also includes planning the timing of work and expenditure on a building. When alternative techniques or components are available, they should be evaluated and choices made so that the client obtains maximum benefit.

Planning should also take into account the effect of performance and qualitative alternatives, for example:
z

the effect on the occupants of reducing the average temperature inside the building during winter by, say, 2C; the type and quality of decoration, which may have an effect on the morale and/or output of the occupants.

Like most forms of planning, the plan produced should not be too rigid. Short-term plans need to be in considerable detail, but longer-term plans (e.g. the full functional life plan) will be drawn up in more general terms and should be updated at intervals to take account of changing circumstances and environmental changes.

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10 Discount rates
In life cycle cost calculations, it is necessary to take account of both initial and future costs. However, future costs cannot simply be added to initial costs to arrive at a life cycle cost due to the effects of inflation and interest rates. Future expenditure is therefore converted to its net present value (NPV) using a discount rate. A discount rate is established by considering the anticipated rates of interest and inflation. The discount rate selected will depend on whether future costs in the calculations are either:
z

nominal, i.e. allowance is made within future costs for possible changes in cost due to inflation or deflation; real, i.e. future costs are represented by current costs, without adjustment for inflation or deflation.

If nominal costs are used, the discount rate is based on interest rates only. If real costs are used, the discount rate used will take account of both interest rates and inflation. In the examples in this study paper, real costs are used. In the examples in this study paper, the discount rate used is 5%. While it will not always be appropriate to use 5% when undertaking life cycle cost calculations, for the purposes of this module this will be acceptable. Because of the difficulties of deciding on a discount rate, it is worthwhile undertaking a sensitivity analysis. This means that the calculations are redone several times, each time using a different discount rate. This allows comparison of the outcomes with the original calculations to ensure that a valid recommendation is made to the client. Sensitivity analysis is explained further in Section 16 below.

10.1 Interest
The interest rate used might be based on:
z z z z z z

The interest cost of a loan for the investment The interest lost on reduction of cash on deposit Returns lost on investment elsewhere (e.g. in bonds or equities) The risk and uncertainty of the proposed investment The actual return achieved on capital investment in the business The required investors rate of return in a business involving the constructed asset

Source: BSI (2008b). The following should be considered when deciding on what interest rate to use:
z

Most developers borrow money to finance their building work, so the cost of borrowing money in the marketplace the market rate for money borrowed on the security of the building could form the basis for calculations. Some developers use their own money, sacrificing the benefits of the alternative uses of that money. The average return the developer could expect to obtain by using these funds for a project of similar risk is another method of deciding an interest rate.

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Even if the developer borrows money, he may have the opportunity of using the funds in another project, and the return on this may form the basis for the rate of interest. This alternative, described as opportunity cost of cash, is sometimes difficult to evaluate. The rate of interest at which receipts from the project (i.e. the rent received from the development, or the profits of the functions carried out in the building) could be reinvested could form another method of assessing the rate of interest. A less satisfactory method of determining the rate of interest is to base it on the minimum rate of return acceptable to the developer. This will include an element of risk as well as the cost of borrowing. The rates of interest used in valuing businesses also involve an allowance for business failures. Buildings generally have a longer life than businesses, and there is a smaller investment risk because most buildings have several potential users and can therefore be sold with little or no loss. The market rate for money is probably the simplest rate to use, as it is easiest to ascertain. Where funds for a project are obtained from different sources (e.g. retained company earnings, issue of new shares, fixed interest capital borrowing), a weighted average of the various rates for each source may be used.

10.2 Allowing for inflation

When inflation rates are low there tends to be a fairly constant relationship between the inflation rate and the base rate of interest. The following method of allowing for inflation is used in this paper. If the costs of all items are assumed to rise at a similar rate, the discount rate used for life cycle cost calculations can be the difference between the rate of inflation and the market rate for borrowing money. This is similar to the use of low yield inflationproof investment rates used to calculate the values of some prime building properties.
EXAMPLE 1 All costs in connection with a project are expected to rise at 3% per annum over the life of the project. The market rate for borrowing money is 6%. Suggest a discount rate for use in the whole life cost calculations. In this case, the rate of interest used in the whole life cost calculations could be an inflation-free discount rate of 3% (i.e. 63).

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11 Use of discount tables

All expenditure which is going to occur in the future is converted to its NPV using discount rates, and to assist with this, discount tables are used (see Appendix A). It is common for students to find this concept difficult to understand. In order to gain the required understanding of the use of discount tables, you should work through each of the following examples. Use the tables in Appendix A to ensure that you know where the figures in each calculation have come from. Take your time, complete each example before moving on to the next.

11.1 Use of present value of 1 table

The present value (PV) of 1 table converts a future cost occurring in a specific year to an NPV. Example 2 below shows how to calculate the NPV for replacing a boiler in 20 years time.
EXAMPLE 2 A boiler is going to be replaced in 20 years at a cost of 5,000. What is the NPV of this cost?
z z z

Look at the PV of 1 table in Appendix A. The PV of 1 at Year 20 = 0.37689. Multiply the cost of replacement by 0.37689. So the NPV of replacing the boiler = 5,000 x 0.37689 = 1,884.

For periodic costs, the cost value does not vary over time. Repair costs for Year 5 are taken as the same for Year 10 and then 15. The cost is not inflated. Allowance for this is made in the choice of the discount rate used (see Section 10). For a series of payments made at, say, five-yearly intervals, it is therefore useful to add together the values from the discount table and multiply the repair or replacement cost by the one value. This is shown in Example 3.
EXAMPLE 3 A boiler is to be maintained at five-yearly intervals prior to replacement in Year 20. The maintenance cost is 700 each time. What is the NPV of this cost? Look at the PV of 1 table in Appendix A The PV of 1 at Add the total Multiply the annual cost by 1.87846. The NPV of maintaining the boiler = 700 x 1.87846 = 1,315. Year 5 = Year 10 = Year 15 = 0.78353 0.61391 0.48102 1.87846

Repair, maintenance and replacement costs are generally not allowed for in the final year of a buildings life. If the life of a building is 50 years, and repairs are being carried out at five-yearly intervals, no repairs will be allowed for in Year 50. The last year that repairs will be carried out will be in Year 45.

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The exception to this would be if the life cycle cost was being prepared for a PFI project, for example (see Sections 4 and 15.1). In this situation, there is a contractual agreement that the building is to be handed over with defects rectified and agreed maintenance carried out. It is likely therefore that there will be repair, maintenance and replacement costs incurred in the final year. Such costs occurring in the last year will therefore be included in the calculations.

11.2 Use of years purchase table

In Appendix A there is a second table entitled Years purchase. This table is used for costs which occur annually, e.g. cleaning or energy.
EXAMPLE 4 The cleaning costs of a floor finish are 400 per annum. What is the net present value (NPV) of this cost over the 50-year life of the building?

Look at the years purchase (YP) table in Appendix A. The YP at Year 50 = 18.25593. Multiply the annual cost by 18.25593. The NPV of cleaning the floor finish = 400 x 18.25593 = 7,302.

z z

The figures in the YP table are formed by adding the individual figures in the PV of 1. If, for example, a cost was going to occur annually from Year 1 to 3 inclusive, the YP figure that would be used would be 2.72325. This figure is the same as adding the PV of 1 figures for Years 1 + 2 + 3, i.e. 0.95238 + 0.90703 + 0.86384 = 2.72325. You will therefore see the huge benefit of using a YP table to calculate the NPV of annual costs which occur over, for example, the 50-year life of a building. A single figure is used instead of having to add up 50 different figures contained in the PV of 1 table. Annual costs tend to include cleaning and energy costs. For a 50-year period, you should include Year 50, as cleaning and energy costs will be required, even if this is the last year of the building life being considered.
TASKS Calculate the following: 1. The NPV of a 600 cost occurring in Year 25. 2. The NPV of 1,500 occurring annually during a 30-year life of a building. 3. The NPV of a 100 cost occurring in Years 5 and 10. 4. The heating cost of a building is 2,000 per annum. The building life is 40 years, what is the NPV? See Appendix B for the answers.

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12 Examples of life cycle costing calculations

Life cycle costing can be undertaken for whole buildings or just components of buildings. A comparison between alternatives on a life cycle cost basis allows choices to be made, for example between:
z z z z

alternative wall finishes alternative types of window alternative heating installations alternative lift installations.

The costs over the life of an element or building need to be brought back to present day values. As explained in Section 10 and 11 above, in order to compare predicted user costs with initial costs, it is usual to convert future expenditure to its NPV or present discounted figure. IMPORTANT: Do not attempt to work through Examples 5 and 6 below before you have worked through Section 11 above.
EXAMPLE 5 Compare the whole life cost of aluminium and UPVC rainwater goods for a building with an anticipated life of 50 years. The initial costs are 6,500 and 3,700 respectively and the anticipated lives are estimated at 35 years and 15 years respectively. The current cost of replacing the pipes would be 7,250 for aluminium and 4,200 for UPVC. The replacement cost is equal to the initial cost plus an allowance for removing existing and preparation for new installation. A suggested discount rate for calculation purposes is 5%, which allows for inflation. The effect of taxation can be ignored. Aluminium Initial cost PV of 1 NPV () 6,500

Replacement cost Yr 35 7,250 x 0.18129 1,314 7,814 NPV UPVC Initial cost Replacement cost Yr 15 Yr 30 Yr 45 PV of 1 NPV () 3,700 0.48102 0.23138 0.11130 4,200 x 0.82370 3,460 NPV 7,160

A comparison should be made of the short-term (initial) costs and the long-term costs the total net present value. Here it can be seen that even if a considerably larger sum is spent initially for the aluminium, an extra 2,800, there is no long-term benefit to be gained. The total NPV for the aluminium is still higher than that for the UPVC.

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If these figures are part of a report to a client, it would be appropriate to include a table summarising them, as shown below.
Costs Aluminium UPVC Initial 6,500 3,700 Running 1,314 3,460 Total NPV 7,814 7,160

The above estimates can involve errors in pricing and forecasting. Some will be compensating, but it is usually possible to suggest maximum net errors to see whether they are likely to affect the choice. Assuming a maximum error in each direction of 10%, the range of costs for the two items would be: Aluminium 7,0338,595; UPVC 6,4447,876. In this case there is an overlap of the two ranges. More accurate predictions may be carried out, or the choice may be made on other factors. Other factors to be considered which may sway the decision in favour of aluminium are:
z z z z z z

lower running costs the inconvenience of repeated replacement aesthetics performance personal preference the funding of running costs may come from a different source and influence a clients decision.

Example 6 takes the planned maintenance of the wall finishes into consideration in the LCC comparison. Where cost information is not available, it is necessary to make assumptions, and these should be indicated in all calculations. Initial costs, together with future annual costs and periodic costs, are brought back to NPV so that a true comparison can be made of different maintenance profiles. A comparison of initial costs, running costs and total costs can then be made to enable an informed choice. Again, other factors such as inconvenience, aesthetics and performance must also be considered. In Example 6 the annual and periodic costs are assumed figures.

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EXAMPLE 6 The client is considering alternative wall finishes to the main office areas of his building. In a brief report, advise on the short- and long-term implications of these options: a. 12mm tapered edge plasterboard and skim coat, finished with matt emulsion. b. 13mm two-coat plaster to block walls and good-quality wallpaper. Life of the building: 50 years Interest rate: 5% (discount tables are in Appendix A) Initial costs: Plaster 9.50/m Plasterboard and skim 11.20/m Three coats emulsion paint to plastered walls 4.30/m Good-quality vinyl wallpaper 6.50/m Annual cleaning Spot-clean painted walls or wallpaper costs: Repair/replacement: Clean painted walls and repaint every five years Major repair to plasterboard work and repaint every 10 years No repairs to wallpaper Replacement of wallpaper every 10 years Repairs to 5% of plaster every 10 years (Assume all other costs.) a. Plasterboard, skim plus emulsion paint PV of 1 @ 5% Initial cost 11.20 4.30 15.50 Annual cost (assumed) Periodic cost every 5 years 0.20

YP @ 5%

NPV 15.50

18.2559

3.65

5 15 25 35 45 2.20

(Assumed cost for 1 coat and clean) Major repairs 10 20 30 40 (Extra over cost for 5 yrs cost assumed)

0.78353 0.48102 0.29530 0.18129 0.11130 1.85244

4.08

8.50

0.61391 0.37689 0.23138 0.14205 1.36423 NPV

11.60 34.83 (Continued)

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b. Plaster and wallpaper Initial cost 9.50 6.50 PV of 1 @ 5% YP @ 5% NPV 16.00 18.2559 3.65

16.00 0.20

Annual cost (assumed) Periodic cost Plaster repairs

10 20 30 40

0.61391 0.37689 0.23138 0.14205 1.36423

5% of 9.50 Assume removing plaster

0.48 0.12 0.60 1.36423 0.82

Replacement every 10 years Wallpaper 6.50 Assume 2.00 removing paper

8.50

1.36423 NPV

11.60 32.07

This covers the preparation of the figure work. Discussion on the results should be included to complete the answer and this should be presented in report format.

The short-term implications require a comparison of initial costs. The long-term implications require a comparison of life cycle costs. This will also therefore involve comparing running costs during the period of the study. As with Example 5 above, factors other than cost should be highlighted so that full information is made available on which to base a decision. Example 7 provides an example of how life cycle cost calculations can be used to assist a client decide between alternatives for a whole building. In some cases, future costs of adaptation are considered.

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EXAMPLE 7 The developer of a proposed building requires a certain area as soon as possible, but anticipates that in five years time he will need approximately double that area. Three possibilities are to be considered: A Erect a single-storey building immediately, with no allowance for future expansion, and build on a second storey with all necessary alterations in five years time. B Erect a single-storey building with larger bases and stanchions and a stronger roof immediately, so that the second storey can be built in five years time. C Erect a two-storey building immediately without making profitable use of the additional space for five years. Take interest rates as 5% and ignore any effects of inflation and taxation. Initial building costs, including architects fees, building finance etc., will be: A 750,000 B 825,000 C 1,350,000 Extension costs including fees, etc.: A 900,000 B 675,000 Allowance for disturbance: 150,000 Allowance for disturbance: 15,000 30,000 per annum. 750,000 900,000 150,000 1,050,000 .784 Total present cost

Additional user costs caused by second storey in case C: Case A Initial cost Extension cost Allowance for disturbance PV of 1 in 5 years @ 5%

823,200 1,573,200 825,000

Case B Initial cost Extension cost Allowance for disturbance

675,000 15,000 690,000 .784 Total present cost

540,960 1,365,960 1,350,000

Case C Initial cost Additional user cost PV of 1 per annum for 5 years @ 5%

30,000 4.329 Total present cost

129,870 1,479,870

Provided the prediction errors in these figures are low, case B, which makes some provision for future expansion, seems to be the cheapest. If the period before the second storey is required is much longer than five years, the present cost of case A will be reduced most, of case B slightly, but the cost of case C will be increased.

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SELF-ASSESSMENT QUESTION 1. The following alternatives are being considered for the external windows and doors for a building with a life of 50 years: a. White colour-coated aluminium frames with double-glazed units. b. Hardwood stained frames with toughened wired glass. Using the information provided, and any other assumptions you feel necessary, advise on the cheapest option in the long term. Aluminium 58,000 2,000 4,200 Yes Hardwood 49,000 1,500 3,500 Yes

Initial cost of windows and doors Annual cleaning Restaining every 5 years Refinishing every 15 years Replacement every 30 years Replacement every 20 years

Discount tables are available in Appendix A. The answer to this question can be found in Appendix C.

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13 Annual sinking funds and annual equivalents

It is often necessary to calculate a sum of money to be invested at the end of each year to provide a sufficient amount to replace part of the building, at the end of a certain number of years, at a given interest rate. Again, tables are available for use in this exercise, and the annual sinking fund table would be used. We have not provided extracts of this table but you can use the following formula: Annual sinking fund = i [(1+i)n-1]

EXAMPLE 8 Calculate the annual sinking fund to replace 1 in 15 years @ 2%

Annual sinking fund = = =

i [(1 + i)n - 1] 0.025 [(1 + 0.025)15 - 1] 0.025 [1.4483 - 1]

= 0.056 An annual equivalent is used when we wish to show the annual amount that would need to be invested over a number of years to pay for the initial cost of a component and to provide a sum to replace the component. The traditional formula for this is i + s where i is the annual interest rate and s is the annual sinking fund. It is quite common for the sinking fund interest rate to be approximately half the interest rate charged on the initial capital cost.
EXAMPLE 9 The initial cost of a boiler is 3,000 with an estimated life of 15 years. Assuming an interest rate of 5% with 2% for the sinking fund, calculate the annual equivalent. Initial cost Annual sinking fund to replace 1 in 15 years @ 2% (see Example 8 above) Add interest at 5% 3,000 = 0.056 = 0.050 x 0.106 = 318

Annual equivalents can be used to make a comparison between elements or systems. The process follows a typical pattern which is demonstrated in the example below.

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EXAMPLE 10 Working life of buildings Interest rate Annual sinking fund Scheme A Initial cost of building including fees Cost of site Annual running costs Every 20 years replace certain finishes and services Every 30 years replace other services Scheme B Initial cost of building including fees Cost of site Annual running costs Every 20 years replace certain finishes and services Every 30 years replace other services

50 years 5% 2%

6,000,000 800,000 55,000 750,000 500,000

8,000,000 800,000 35,000 450,000 300,000

Scheme A Cost of site Annual equivalent in perpetuity @ 5% Initial cost of building including fees First replacement cost: Year 20 0.37668 0.14204 Year 40 750,000 0.51872 Every 30 years 500,000 0.23137 Present value of initial and replacements Annual equivalent Interest @ 5% Annual sinking fund 2.5% for 50 years

800,000 0.05 6,000,000 40,000

389,040 115,685

504,725 6,504,725

0.05 0.0103 0.0603 392,235 55,000 487,235

Annual running costs Annual equivalent cost of scheme A

SELF-ASSESSMENT QUESTION 2. Using the format for scheme A, prepare the annual equivalent cost for scheme B. Which is the financially more favourable scheme? See Appendix C for the answer.

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14 Sources of data
In the foregoing sections, the theory of life cycle costing calculations has been explained. However, in order to carry out such calculations, it is necessary to establish appropriate costs, maintenance periods, etc. Research has been carried out in this field and published material is now more readily available than in the past.

14.1 Cost data

The following are some of the sources of cost data that can be used:
z

price books for initial costs, e.g. Spons, Wessex, Laxtons, Hutchins, Griffiths (published annually) BCIS, Building Maintenance Price Book BCIS Building Running Costs On Line BCIS, Wessex Alterations and Refurbishment Estimating Price Book Means Costworks (for construction cost information in the USA; also Canada, Mexico and Russia) TSI Luckins Electrical Installation Times Guide and TSI Luckins Mechanical Installation Times Guide Construction Confederation, National Schedule of Rates: Electrical Services in Buildings: 2008/09: Pts 1 and 2 quotations from specialist contractors cost data prepared in own office based on past projects and prepared life cycle costs trade journals articles or case studies in, for example, Building Magazine, Architects Journal, etc. cost data from client.

z z z z

z z

14.2 Maintenance Data

A major consideration in any life cycle calculation is the frequency of maintenance, life of components, cleaning, etc. Sources of information about this include:
z

BS 7543 (2003) Guide to Durability of Buildings and Building Elements, Products and Components BS ISO 15686-7:2008 Buildings and Constructed Assets Service Life Planning: Part 7 Performance Evaluation for Feedback of Service Life Data from Practice Building Performance Group Ltd (2001) Building Services Component Life Manual CIBSE (2008) Guide M: Maintenance Engineering and Management BCIS (2006) Life Expectancy of Building Components trade journals articles or case studies in, for example, Building Magazine, Architects Journal, etc. manufacturers data data prepared in own office based on experience from past projects.

z z z

z z

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15 Risks and uncertainty

In the various calculations required to carry out an analysis of life cycle costs, there are many variables. Predictions have to be made about what will happen in the future, during the life of a building, and the consequent cost implications have to be assessed. A cost consultant can generally estimate the initial cost of building work fairly accurately from his knowledge of prices charged for similar work. The greater the consultants knowledge of factors affecting prices, the more likely he is to reduce the prediction error in his estimate. There are, however, other aspects of the calculations which are subject to greater risk and uncertainty, and for which assumptions will be made.

15.1 Operating life of a building

It is possible to collect information about the age of existing buildings both those that are still in use and those that have been demolished. However, this historic data cannot be directly applied to proposed buildings, which will almost certainly be different in structural design, layout, perhaps of different materials, and subject to different forms of atmospheric conditions from those experienced in the past. User demands for a proposed building are also likely to be different because of technological changes. It is very difficult to assess the future operating life of a building. Many residential buildings in the UK have been in use for over 400 years with few structural alterations. Some old buildings started out as residential properties but their functional life for this purpose came to an end and they are now being used for offices. On the other hand, some residential blocks have been demolished 30 years after erection because of bad workmanship and/or design. An operating life of about 150 years would appear to be a reasonable average for a good quality domestic property. For poorer quality residential blocks the life tends to be less. The functional life of schools is often shorter than the operating life. Because of changes in government educational policies, the functional lives of many smaller schools over 50 years old owned by local education authorities have ended, but their operative lives have continued as the buildings have been converted for leisure, workshop, residential and other purposes. On the other hand, many public schools over 150 years old are still being used for their original purpose. Schools are an example of projects which can use PFI arrangements. In this case, the life for the initial life cycle cost calculations might be based on the initial period during which the partner is responsible for the costs involved in running the building, for example 25 years. Separate calculations will then be carried out for any period required beyond the 25 years. The functional and operative life of many commercial buildings has often been less than 50 years. A life of 30 years is probably more realistic for industrial buildings less if the building is very specialised. In the recent past, industrial buildings have often been built of less durable materials than other types of building. Changes in the function of a building are difficult to forecast but are likely to result in different running costs.

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To forecast the operative life of buildings built now involves trying to foretell the social, technical and other changes likely to occur over the next 10 to 100 years. Moreover, sometimes economically, socially and functionally acceptable buildings have to be demolished for planning requirements such as making way for a new motorway. This situation could arise at any time, and so it is generally not possible to forecast this at the initial stages of a development. In practical terms, when preparing LCC calculations it is best to use the period during which the building is expected to be used by the organisation for which the calculations are being made. The disposal value of the property at the end of this period should be included in the cost calculations. Many LCC calculations are made for comparison purposes. An incorrect assumption will often have a similar effect on all the options and will not affect the decision being made.

15.2 Assessment of component life

Buildings consist of large numbers of components, all with different lives from the maintenance point of view. The lives of most structural components are well over 10 years, but it can be difficult to forecast component lives with any degree of accuracy. There are various sources of data which can be of assistance (see Section 14). It is more difficult to assess the life of new materials or components because historical data is not available. This means that it can be difficult to carry out a comparison between a new and a traditional material. Wildly incorrect statements about the durability of new materials can be made by their manufacturers. For example, some of the early PVC components were subject to colour changes much sooner than either manufacturers or users expected. This defect was quickly overcome so that the later components were much more colour stable. Also, some new materials and construction techniques have resulted in jointing problems. These have not always been overcome so easily, and high and unforeseen maintenance costs have occurred. In some sources of published date, there is also information available relating to the effect of:
z z z

possible manufacturing, design and workmanship faults climatic corrosion user wear.

All the above will result in the early failure of the component. However, such effects may or may not occur in the building being considered, so a judgement has to be made. In Whole-life Economics of Building Services, Ronald Hurst et al. (2005: iv) cite an example of how, through refurbishment, the life of a primary component, such as a boiler, can be extended by the replacement of secondary components, such as burners, flue pipes, etc. If this is done, then the boiler could be said to have a 60-year life, although possibly only the boiler casing itself will remain original over this timescale. In some publications, the upper and lower limits of the life of elements, building materials or components can often be found and comparisons made. The choice of a suitable life for a product therefore remains a risk.

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15.3 Extent of repairs

In LCC calculations, it is often necessary to make an allowance for partial replacement or repair, rather than allowing for full replacement. In this situation, a percentage allowance of, say, 20% may be made for such partial replacement or repair. This allowance may be based on past experience, but may not be an accurate assessment of what will happen in the proposed building and therefore could be an uncertainty.

15.4 Reliability of component life data

The reliability of the published data used in connection with life expectancy of components or materials, and the required maintenance cycles must be considered. While published information on the life of components is available, this must be used with care and remains a developing field. It is important to consider the background of how this data has been prepared. Does it relate to a specific type of building, with a specific level of use, in a specific location with particular weather conditions, etc.? In general, it should also be remembered that published component life data assumes that all required maintenance recommendations have been followed. BCIS (2006:1) Life Expectancy of Building Components contains the following guidance in relation to the results of its survey of the life expectancies of common building components: The results do not take into account specific design, construction, location, positioning, local ground conditions, air quality, loading or mis-use that may occur and thus a degree of professional interpretation is needed when being used in specific circumstances. Any one of the factors included in the above quotation can shorten or lengthen the life of components by substantial amounts.

15.5 Changes in technology, fashion, availability of spare parts

When a component requires replacement, this might not be possible owing to unavailability of spare parts. Technology might have changed, and the client may wish to upgrade to the most recent developments. Another circumstance might be that the client wishes to change to keep up with fashion or wishes to portray a different image. These are all difficult factors to predict.

15.6 Building in use

While great care can be taken over the selection of appropriate cost data, life of components, maintenance cycles, etc., how the building is used by the client during occupation will affect how closely the life cycle calculations reflect actual usage. It is often necessary to replace the components of a building several times during its life, and the life of a building may depend on whether efficient and regular repair and maintenance have been carried out. All buildings deteriorate naturally but deterioration may be accelerated as a result of human endeavours. It is the human factor that makes determining component and material life expectancy difficult (BCIS 2006: 1).

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Life cycle calculations tend to reflect what is hoped for in an ideal situation. However, as with life in general, what happens in the future life of a building often is not what is hoped for at the planning stage. Unexpected situations arise which cannot be taken into account in the calculations. Some examples include:
z z

Early failure of components or material owing to design or construction error. Financial problems may mean that maintenance cannot be carried out when planned, perhaps resulting in more major expenditure later. It is assumed that the client will carry out all maintenance as detailed in the maintenance programme and recommended by manufacturers. This may not be the case. The client may cease to want to use the building as was originally intended, e.g. owing to diversification in the product being produced in a factory, a major refurbishment of the property is required which was not allowed for originally. The client may want existing property extended, which will have an impact on, for example, the existing services to the property.

15.7 Assessment of future costs

In the calculations used in this study paper, costs of future replacements have been based on the cost of the work in the initial construction. So, for example, the cost of replacing a boiler will be based on the cost of originally installing the boiler. Adjustments to this cost have to be made for:
z z z

removing and disposing of the original boiler difficulty in working in a building which is in occupation additional access problems (restrictions on working times, etc.).

It is vital that consideration is given to all possible additional costs in order to avoid life cycle costs which do not accurately reflect future costs.

15.8 Reliability of maintenance cost information

The professional institutions and other organisations are now obtaining more information on maintenance costs. This has been difficult, but eventually the information should lead to a reduction in prediction errors in this field. Care must be taken when using cost information from published sources. It should be noted that different sources of cost information are likely to be subject to variation. In the case of published data, for example:
z

Publishers of cost data may be using average prices, and the method used to obtain the average may be statistically suspect. Published costs may be recalculated at infrequent intervals and there may be no indication of the last revision date. (This also applies to some trade periodicals.) The items included in the cost of elements may not be the same in each case, owing to:
{ {

differences in the requirements of the publishers inefficiency or lack of knowledge on the part of the person analysing.

There may be genuine mistakes, including printing errors.

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Variations in cost data do not invalidate their use, but the user must be capable of interpreting cost information in its context and adjusting it correctly in order to reuse it. Using costs from sources whose backgrounds are little known is the least reliable option. Generally, the most reliable cost information will come from previous projects that are known to the person preparing the life cycle costs, or from the client if he has other similar properties and records relating to maintenance costs incurred. Using such information allows consideration of and adjustment, if required, for various factors such as changes in Building Regulations (e.g. which have an impact on energy performance targets), specific site or design characteristics of the building, contract procurement differences, etc. For all costs, it is necessary to consider adjustment to take account of differences in location of the project (using locational indices) and differences in pricing levels (using tender price indices), which will allow for updating of historical costs to current costs, and also take account of economic climates. Where your course requires you to have knowledge of this updating process, information about indices will be contained in other study papers in your course.

15.9 Escalation of labour or material costs

While the discount rate used will include an allowance for inflation, there may be changes in cost which could not be predicted, e.g. a rise in all prices of copper components by 50% due to a shortage of copper. This could have a significant impact on a comparison between copper and an alternative material if the copper option originally had the lower net present value in the LCC comparison.

15.10 Energy costs

Energy costs can change as a result of arbitrary decisions made by governments witness recent changes in oil prices throughout the world. A rapid change in the price of a certain type of fuel without a similar change in others can render incorrect a decision made on the most economic heating system for a property. Many clients require their buildings to have low energy consumption and running costs, if not for their own benefit then as a selling or letting point. Some natural resources may become exhausted or obsolete over the life of a building. Technological improvements are likely to provide alternatives, though these can rarely be forecast more than 20 years ahead. The heat source may be able to be changed for a more efficient model and connected to an existing distribution system.

15.11 Discount rate

It is difficult to determine discount rates suitable for calculating total building costs. This is because it is difficult to estimate the cost of capital, and even more difficult to estimate future inflation rates. For the purposes of the exercises included here, the discount rate is adjusted to take inflation into consideration (see Section 10 above).

15.12 Impact of risks and uncertainties

The entire technique of life cycle costing is based on a series of predictions in which there will inevitably be some error. For the purposes of cost comparison, the accuracy of the estimated cost may not be important in itself unless it leads to an incorrect conclusion. Many estimates and predictions will have similar errors for each of the items being considered, so decisions based on the final figure will still be correct. However, to test the effect, sensitivity analysis should be carried out (see Section 16).

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The annual equivalent of the initial cost of a building is not very sensitive to small changes in the buildings life unless it is a very short one, when errors of prediction do have more effect. Valuers generally ignore any sinking fund in their calculations of value when the life is a normal length, as the figure is so insignificant. Because of the greater variation in annual equivalents with shorter lives, it is better not to be too conservative in predictions; otherwise a false result may be obtained. This is illustrated in Example 11.
EXAMPLE 11 What will be the effect on the annual equivalent of the initial cost of a building if the estimated life is taken as: 1. 2. 3. 4. 10 years 25 years 50 years 75 years?

The initial cost including fees, etc. is 100,000 and the rate of interest 5% with 2% for the sinking fund. 1 Initial cost Annual sinking fund (ASF) to replace 1 in 10 years @ 2% Interest @ 5% Annual equivalent 2 Initial cost ASF to replace 1 in 25 years @ 2% Interest @ 5% Annual equivalent 3 Initial cost ASF to replace 1 in 50 years @ 2% Interest @ 5% Annual equivalent 4 Initial cost ASF to replace 1 in 75 years @ 2% Interest @ 5% Annual equivalent 100,000 = .089 = .050 .139 = 13,900 100,000 = .029 = .050 .079 = 7,900 100,000 = .010 = .050 .060 = 6,000 100,000 = .005 = .050 .055 = 5,500

When the life of a building is fairly short, as in cases (1) and (2), any change in the length of life can have a considerable effect on the annual equivalent, but as the life grows longer, e.g. (3) and (4), quite large differences in the length of life (in these cases 25 years) make very little difference to the annual equivalent.

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16 Sensitivity analysis
Examples show that if a certain prediction error applies, a variety of answers may be thrown up. Moreover, where calculations of NPV for alternatives are fairly close together, a slight change in data could affect the result. In these cases it is advisable to look at the calculation carefully and apply a range of allowances to see what effect the changes have on the result. This technique is known as sensitivity analysis. It is merely seeing how sensitive the results are to changes in the major components of the calculation, such as:
z z z

life of component costs of future maintenance discount rate.

It is necessary to redo the life cycle cost calculations several times, changing one component of the calculation at a time. For example, change the frequency of maintenance from every 15 years, to every 10, 12 or 18 years. By doing this, it is possible to establish the most likely case, as well as the best and worst case scenarios. Some changes made to the calculations will have little effect on the NPV, while others may have a much more significant impact. Where there is a significant impact, then that particular factor or assumption is described as being sensitive. The important point, however, is to consider whether or not the change would alter the recommended choice, e.g. between aluminium or UPVC rainwater goods in Example 5 above. If the recommendation would continue to be UPVC despite replacing the rainwater goods more frequently, then, in this situation, the frequency of replacement is not sensitive to change. On the other hand, as soon as the change made in the calculations results in a change in your recommendation, then you have established that the factor is sensitive. It is therefore necessary to review the calculation carefully. Where initial calculations of the NPV are prepared on, for example, an Excel spreadsheet using cell formulae, it is relatively straightforward to carry out a simple sensitivity analysis as described above. Various computer programs are also available to deal with these calculations.

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17 Report for client

When all the calculations have been completed, and the sensitivity analysis carried out, it is necessary to prepare a report for the client. A report could include the following information:
z

Summary of clients specific requirements for the life cycle cost study undertaken with details of any agreed parameters. Details of any assumptions made in undertaking the study. Details of any risks or uncertainties considered, and their impact on the study. This should be backed up with outcome results of sensitivity analysis undertaken. Summary of results within the report, full details being contained in appendices. Details of factors other than cost which the client should consider before making the final choice between options.

z z

18 Summary
In this paper we have provided information about whole life costing and life cycle costing. We started by thinking about value for money, recognising that this will have different meanings for different people. Value for money leads to the need to consider, not just the initial cost of construction, but also the ongoing costs which a building owner will incur throughout the life of a building. We identified the many initial and future running costs which are associated with owning a building and looked also at the importance of thinking about the most appropriate life of the building. We looked at the different calculations which have to be undertaken in order to evaluate life cycle costs in relation to alternative design options which can be considered in order to achieve long-term value for money through the consideration of both initial and future costs associated with the building. Problems which can be encountered in the preparation of life cycle cost calculations have been identified, together with the importance that sensitivity analysis has in verifying results. In order to predict costs over the life of a building, it is important to obtain as much information as possible on the lives of different materials, how they can be affected by changes in atmospheric conditions, and the effect of other materials on them for example electrolytic action in the case of copper and galvanised mild steel. Record the cost of carrying out maintenance work where possible, with items broken down into small convenient units, thus building up a database of cost information. To apply life cycle costing techniques efficiently, it is necessary to combine a knowledge of various subjects, including building technology, materials, pricing, maintenance, taxation and economics.

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19 Further reading
What is life cycle costing? Why is it important? Who is involved? These and other questions are answered at: www.ogc.gov.uk/implementing_plans_introduction_life_cycle_costing_.asp Office of Government Commerce (2007) Whole-life Costing and Cost Management: Achieving Excellence in Procurement Guide 7, OGC. This guide explains how to manage costs throughout the life of a facility. The focus is on whole-life costs that is, the cost of design and construction, the long-term operational and maintenance costs and the costs associated with disposal. The guide outlines the principles of whole life cost management and describes a process made up of:
z z z

a framework for cost management establishing baseline costs expected operational costs of the asset estimating whole-life costs every cost likely to be incurred from inception of the project to disposal, construction costs and risk allowance cost management and reporting.

This paper that can be found at www.ogc.gov.uk/documents/CP0067AEGuide7.pdf

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Bibliography
BCIS (2006) Life Expectancy of Building Components: A Practical Guide to Surveyors Experiences of Buildings in Use, London: BCIS. ISBN-13: 9781904829393. BCIS (2009a) Building Maintenance Price Book, London: BCIS. ISBN-13: 9781904829911. BCIS (2009b) Building Running Costs Online. Available at www:bcis.co.uk/site/scripts/documents_info.aspx?documentID=63 [accessed 9 July 2009]. BSI (2008a) BS ISO 15686-5:2008: Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing, London: BSI. ISBN-13: 978-0580540837. BSI (2008b) Standardized Method of Life Cycle Costing for Construction Procurement, A Supplement to BS ISO 15686-5 Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing, London: BSI. ISBN-13: 9780580626623. Building Performance Group Ltd (2001) Building Services Component Life Manual, London: Blackwell Science Ltd, pp. xvi, xvii, 53, 55. ISBN-13: 978-0632058877. Hayden G W and Parsloe C J (1996) Application Guide 15/96: Value Engineering of Building Services, Bracknell: BSRIA (Revised 2005). ISBN-13: 978-0860226543. Hurst R, Williams B and Lay M (2005) Whole-life Economics of Building Services, Bromley, Kent: International Facilities and Property Information Ltd. ISBN-10: 0904237265. RICS (1998) Surveyors Construction Handbook, London: RICS Books. ISBN-13: 978-0854068654 (out of print but available online via isurv).

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Appendix A: Discount tables

Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 Present value of 1 5% 0.95238 0.90703 0.86384 0.82270 0.78353 0.74622 0.71068 0.67684 0.64461 0.61391 0.58468 0.55684 0.53032 0.50507 0.48102 0.45811 0.43630 0.41552 0.39573 0.37689 0.35894 0.34185 0.32557 0.31007 0.29530 0.28124 0.26785 0.25509 0.24295 0.23138 0.22036 0.20987 0.19987 0.19035 0.18129 0.17266 0.16444 0.15661 0.14915 0.14205 0.13528 0.12884 0.12270 0.11686 0.11130 0.10600 0.10095 0.09614 0.09156 0.08720 Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 Years purchase 5% 0.95238 1.85941 2.72325 3.54595 4.32948 5.07569 5.78637 6.46321 7.10782 7.72173 8.30641 8.86325 9.39357 9.89864 10.37966 10.83777 11.27407 11.68959 12.08532 12.46221 12.82115 13.16300 13.48857 13.79864 14.09394 14.37519 14.64303 14.89813 15.14107 15.37245 15.59281 15.80268 16.00255 16.19290 16.37419 16.54685 16.71129 16.86789 17.01704 17.15909 17.29437 17.42321 17.54591 17.66277 17.77407 17.88007 17.98102 18.07716 18.16872 18.25593

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Appendix B: Answers to tasks

Calculate the following: 1. NPV of a 600 cost occurring in Year 25: 600 x 0.29530 = 177 2. NPV of 1,500 occurring annually during 30-year life of a building: 1,500 x 15.37245 = 23,059 3. NPV of a 100 cost occurring in Years 5 and 10: Year 5 Year 10 100 x 0.78353 100 x 0.61391 NPV = 78 61 = = 139

Alternative layout of calculation (reduces number of calculations and so likelihood of errors) Year 5 Year 10 NPV 0.78353 0.61391 100 x 1.39744 = 140

Although there is a slight difference between the answers (139 and 140), this is purely as a result of rounding the numbers and is acceptable. For these calculations, we round to the nearest whole unit of currency. If you redo the above calculations, correct to two decimal places, you will see that both will give an answer of 139.74. 4. The heating cost of a building is 2,000 per annum. The building life is 40 years, what is the NPV? Year 40 NPV 2,000 x 17.15909 = 34,318.18

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Appendix C: Answers to self-assessment questions

QUESTION 1 PV of 1 @ 5% Years purchase @ 5% NPV

a Aluminium Initial cost Annual cleaning Periodic cost every 15 yrs (replaced in year 20) Refinishing Replacement note below) (see 15 35 4,200 0.48102 0.18129 0.66231 2,782 58,000 2,000 1 18.2559 58,000 36,512

20 40 60,000

0.37689 0.14205 0.51894 NPV 31,136 128,430 49,000 18.2559 0.78353 0.61391 0.48102 0.37689 0.29530 0.18129 0.14205 0.11130 3,500 2.98529 10,449 27,384

b Hardwood Initial cost Annual cost Periodic cost every 5 yrs 5 10 15 20 25 35 40 45 Restaining Replacement note below) (see 49,000 1,500 1

30

51,000

0.23138 NPV

11,800 98,633

Note: Replacement cost = initial cost + assumed cost of removing existing windows.

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QUESTION 2 Scheme B Cost of site Annual equivalent in perpetuity @ 5% Initial cost of building including fees First replacement cost: Year 20 0.37668 0.14204 Year 40 450,000 0.51872 Every 30 years 300,000 0.23137 Present value of initial and replacement costs Annual equivalent Interest @ 5% Annual sinking fund 2.5% for 50 years

800,000 0.05 8,000,000 40,000

233,424 69,411

302,835 8,302,835

0.05 0.0103 0.0603 500,661 35,000 575,661

Annual running costs Annual equivalent cost of scheme B

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Appendix D: Extract from BSI (2008) Standardized Method of Life Cycle Costing for Construction Procurement, A Supplement to BS ISO 15686-5 Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing: Annex A: Menu of life cycle costs and whole life cycle costs, pp. 5455.

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Appendix E: Extract from BSI (2008) Standardized Method of Life Cycle Costing for Construction Procurement, A Supplement to BS ISO 15686-5 Buildings and Constructed Assets Service Life Planning: Part 5 Life Cycle Costing: Annex D: Worked examples, pp. 6063.

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Appendix F: BCIS (2006) Life Expectancy of Building Components: A Practical Guide to Surveyors Experiences of Buildings in Use, pp. 2, 11, 22, 221, 327, 340.

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Appendix G: Building Performance Group Ltd (2001) Building Services Component Life Manual, London: Blackwell Science Ltd, pp. xvi, xvii, 53, 55.

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Appendix H: BCIS (2009) Building Maintenance Price Book, pp. 5, 58, 182, 247.