life cycle cost analysis - info 1

8/9/2019 Life Cycle Cost Analysis - Info 1

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May 2007

Final Methodology

Life Cycle Costing(LCC) as acontribution tosustainable

construction: acommonmethodology


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Life Cycle Costing (LCC) as a contribution to sustainable construction: a common methodology

Davis Langdon Management Consulting May 2007

Contents

Tables and figures ............................................................................... i 0 Introduction ......................................................................................... 1 1 STEP 1: Identify the main purpose of the LCC analysis .................... 10 2 STEP 2: Identify the initial scope of the LCC analysis ....................... 13 3 STEP 3: Identify the extent to which sustainability – and specifically

environmental – analysis relates to LCC ...........................................17 4 STEP 4: Identify the period of analysis and methods of economic

evaluation.......................................................................................... 20 5 STEP 5: Identify the need for additional analyses (risk/uncertainty and

sensitivity analyses) .......................................................................... 26 6 STEP 6: Identify project and/or asset requirements – confirm key

parameters........................................................................................ 33 7 STEP 7: Identify options to be included in the LCC exercise ............ 38 8 STEP 8: Assemble cost and time data to be used in LCC analysis ... 40 9 STEP 9: Verify values of financial parameters and period of analysis46 10 STEP 10 (Optional): Review risk strategy and carry out preliminary

uncertainty/risk assessment ..............................................................49 11 STEP 11: Perform required economic evaluation. ............................ 50 12 STEP 12: Carry out detailed risk/uncertainty analysis (if required) ... 55 13 STEP 13: Carry out sensitivity analysis (if required) ......................... 58 14 STEP 14: Interpret and present initial results in required format....... 61 15 STEP 15: Present final results in required format and prepare a final

report. ...............................................................................................63

Annex A: Sample tabular and graphical outputs from typical LCC exercisesAnnex B: Bibliography and references


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Tables and figures

Tables

1 Summary and overview of steps2 Typical applications of LCC3 Impact of risk on decision-taking4 Generic cost classification and check list5 Factors affecting durability6 Examples of the application of LCC analysis

Figures

1 Core process of LCC2 Methodology flow diagram3 Risk management cycle4 Common tools and techniques in risk/uncertainty analysis

5 Probability matrix6 Calculation of NPV7 Risk profile in histogram form8 Risk profile in cumulative form9 Spider diagram10 Spider diagram with contour lines11 Sample project data table12 Sample annual expenditure table13 Sample table of key parameters14 Sample tabulation of total cost profile15 Sample LCC model

16 Sample component replacement cost build-up17 Sample cost profile chart18 Sample cost profile chart19 Sample cumulative cost chart20 Sample component option appraisal cost chart


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0 Introduction

0.1 Background

In 2006 the European Commission appointed Davis Langdon from the UK to undertake aproject

(1) to develop a common European methodology for Life Cycle Costing (LCC) in

construction.

The origins of the project lay in the Commission’s Communication ‘The Competitiveness of

the Construction Industry’ and, more specifically, in the recommendations of the

Sustainable Construction Working Group established to help take forward key elements of

the Competitiveness study. These recommendations proposed that a Task Group (TG4) be

established to prepare a paper on how Life Cycle Costing could be integrated into European

policy making. The Task Group’s paper(2)

recommended the development of a common

LCC methodology at European level, incorporating the overall sustainability performance

of building and construction.

The project was undertaken in recognition that a common methodology for LCC in

construction is required across Europe in order to:

Improve the competitiveness of the construction industry

Improve the industry’s awareness of the influence of environmental goals on LCC

Improve the performance of the supply chain, the value offered to clients, and clients’

confidence to invest through a robust and appropriate LCC approach

Improve long-term cost optimisation and forecast certainties

Improve the reliability of project information, predictive methods, risk assessment and

innovation in decision-making for procurement involving the whole supply chain

Generate comparable information without creating national barriers and also considering

the most applicable international developments.

0.2 Purpose of this methodology

It was recognised early on in the research process that LCC is applied in various ways and

with differing parameters across the EU, and that a single prescriptive methodology would

not be appropriate. Therefore this document provides a methodological framework for the

common and consistent application of LCC across the EU without attempting to replace

country-specific decision models and approaches. It identifies the key considerations to be

taken into account at each stage in the LCC process and provides practical guidance on the

application of LCC in a number of common scenarios. It is aimed primarily at public sector

construction clients and their project advisors, but can also be used by private sector clients

and their advisors, and by contractors.

0.3 Using this methodology

LCC may be applied in a wide range of circumstances in construction, for example in a

project to invest in:

A single complete constructed facility such as a building or civil engineering structure

An individual component or assembly within a facility

A portfolio comprising a number of facilities.

LCC may also be applied in the context of existing constructed assets, for example as a

means of assessing future operational budgets or for evaluating refurbishment and renewal

options.


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The period of analysis adopted for an LCC exercise may similarly vary. LCC may be

employed to inform decisions throughout the complete life cycle of a constructed asset or

for a selected limited period within it. However, irrespective of how or when LCC is

applied, the core evaluation process as summarised in Figure 1 below remains the same.

(1): Life cycle costing (LCC) as a contribution to sustainable construction: a common methodology’ No. 30-CE-0043513/00-47.(2): Task Group 4: Life Cycle Costs in Construction; Version 29 October 2003, Enterprise Publications, European Commission.Endorsed during 3

rd Tripartite Meeting Group (Member States/Industry/Commission) on the Competitiveness of the

Construction Industry.


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Figure 1: Core process of LCC

Defining the objective of the proposed LCC analysis

Preliminary identification of parameters and analysis

requirements

Confirmation of project and facility requirements

Assembly of cost and performance data

Carry out analysis, iterating as required

Interpreting and reporting results

The purpose of the LCC analysis as defined in the first step in Figure 1 will determine the

scope and detail of subsequent steps. To be effective, the process should be undertaken

collaboratively between all key stakeholders in the project.

The LCC process is essentially iterative, both in the context of assessing options for a

decision at a specific point and of repeating the analysis at future points in the life cycle of a

project in the light of increasingly detailed information or changing client requirements.

The methodology does not seek to represent these potential iterations, rather it takes the

user through a series of numbered steps that follow a logical train of thought, as shown onthe flow diagram included as Figure 2 below.

The steps in this methodology are not intended to reflect the actual chronology of a project

to invest in a constructed asset. The accompanying guidance note contains a series of

practical case studies that will assist the user in applying the methodology steps to the time

line of an actual project.

Figure 2 below summarises the methodology steps as a flow diagram. The following 15

sections of this document relate to the individual steps in the methodology and are

numbered accordingly.. Section 0.4 below provides an overview of the outcomes for the

user as a result of taking each step.

A number of steps relating to uncertainty and risk are optional and shown to be taken if

required, because their application depends on early decisions at Step 5, concerning the

extent to LCC analysis will be supported by risk/uncertainty analyses.

The steps generally use a vocabulary appropriate to a project to construct a facility but the

essential principles set out are entirely applicable to any constructed asset.

The methodology assumes that the user comes to it with a project in view for which the

purpose, scale and initial capital cost have been broadly defined.

The approach to the development of the LCC methodology was inspired by the Engineering

Design Process (EDP). This is a structured decision-making process (often iterative), used

in the development of engineering systems, components or processes to meet desired needs.


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Among the fundamental elements of the design process are the establishment of objectives

and criteria, synthesis, analysis, construction, testing, and evaluation. These broadly defined

stages can be further subdivided into a more detailed process, which includes identifying a

need, defining the problem, conducting research, narrowing the research, analysing set

criteria, finding alternative solutions, analysing possible solutions, making a decision,presenting the product, and communicating and selling the product. EDP is a well known

and established framework used world-wide, therefore applying it to the development of the

methodology ensured that there were no omissions of any activities and that a logical

sequence of steps was maintained.


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Davis Langdon Management Consulting

Figure 2: Methodology flow diagram


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0.4 Overview of outcomes

Table 1 below summarises the outcomes that can be expected on completion of each of the

steps in the methodology. Note that Steps 10, 12 and 13 are optional.

Table 1: Summary and overview of Steps

STEP OUTCOME / ACHIEVEMENT

1 Identify the mainpurpose of the LCCanalysis

Statement of purpose of analysisUnderstanding of appropriate application of LCC andrelated outcomes

2 Identify the initial scopeof the analysis

Understanding of:Scale of application of the LCC exerciseStages over which it will be applied

Issues and information likely to be relevantSpecific client reporting requirements

3 Identify the extent towhich sustainabilityanalysis relates to LCC

Understanding of:Relationship between sustainability assessment and LCCExtent to which the outputs from a sustainabilityassessment will form inputs into the LCC processExtent to which the outputs of the LCC exercise will feedinto a sustainability assessment

4 Identify the period ofanalysis and themethods of economicevaluation

Identification of the period of analysis and what governs itschoiceIdentification of appropriate techniques for assessinginvestment options

5 Identify the need foradditional analyses(risk/uncertainty andsensitivity analyses)

Completion of preliminary assessment of risks/uncertaintiesAssessment of whether a formal risk management planand/or register is requiredDecision on which risk assessment procedures should beapplied

6 Identify project andasset requirements -

Definition of the scope of the project and the key featuresof the assetStatement of project constraintsDefinitions of relevant performance and qualityrequirements

Confirmation of project budget and timescalesIncorporation of LCC timing into overall project plan

7 Identify options to beincluded in the LCCexercise and cost itemsto be considered

Identification of those elements of an asset that are to besubject to LCC analysisSelection of one or more options for each element to beanalysedIdentified which cost items are to be included

8 Assemble cost and time(asset performance andother) data to be usedin the LCC analysis

Identification of:All costs relevant to the LCC exerciseValues of each costAny on-costs to be appliedTime related data (e.g. service life/maintenance data)


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9 Verify values offinancial parametersand period of analysis

Period of analysis confirmedAppropriate values for the financial parameters confirmedTaxation issues consideredApplication of financial parameters within the costbreakdown structure decided

10 Review risk strategyand carry outpreliminary uncertainty/risk analysis

Schedule of identified risks verifiedQualitative risk analysis undertaken – risk register updatedScope and extent of quantitative risk assessmentconfirmed

11 Perform requiredeconomic evaluation

LCC analysis performedResults recorded for use at Step 14

12 Carry out detailedrisk/uncertainty analysis(if required)

Quantitative risk assessments undertakenResults interpreted

13 Carry out sensitivityanalyses (if required)

Sensitivity analyses undertakenResults interpreted

14 Interpret and presentinitial results in requiredformat

Initial results reviewed and interpretedResults presented using appropriate formatsNeed for further iterations of LCC exercise identified

15 Present final results inrequired format andprepare a final report

Final report issued, to agreed scope and formatComplete set of records prepared to ISO 15686 Part 3

0.5 Tailoring the methodology to the specific project circumstances

It is important to note that in practice it will often be possible for users to combine several

of the above steps in order to tailor the methodology to the size of the project, the project

stage and the level of detail required. For example, Steps 1 to 6 are concerned with

defining the objectives and the analysis parameters. On smaller projects this definition

exercise might typically take the form of a meeting or telephone discussion with the client

and/or an exchange of correspondence. Similarly, the risk and sensitivity analyses might be

incorporated into the economic evaluation exercise (Step 11) based on a small number of

agreed parameters and/or the practitioner’s experience of common risk issues. Regardless

of the scale or scope of the exercise, the guiding principle should always be that the key

issues identified in this methodology are all considered, albeit at a level of detail

appropriate to the particular exercise.

0.6 Definitions

This methodology is intended to be compatible with ISO 15686 Part 5 which is currently at

the DIS ballot stage and is likely to be adopted shortly. Definitions used in this

methodology are therefore as in ISO 15686 Part 5. For ease of use, key definitions are

reproduced below.

Life Cycle Costing

A technique which enables the systematic appraisal of life cycle costs over a period of analysis, as

defined in the agreed scope.


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Life Cycle Cost

Assessment expressed in monetary value taking into account all significant and relevant costs over

the life cycle, as defined in the agreed scope. The projected costs are those needed to achieve definedlevels of performance, including reliability, safety and availability over the period of analysis.

Life Cycle

Consecutive and interlinked periods of time between a selected date and the disposal of the asset,

over which the criteria (e.g., costs) are assessed. This period may be determined for the analysis

(e.g., to match the period of tenancy or ownership) or cover the entire life cycle. The life cycle period

shall be governed by defining the scope and the specific performance requirements for the particular

asset.

Nominal Cost

Expected price which will be paid when a cost is due to be paid, including estimated changes in price due to, for example, forecast change in efficiency, inflation or deflation and technology

Real Cost

Cost expressed as a value as at the base date, including estimated changes in price due to forecast

changes in efficiency and technology, but excluding general price inflation or deflation

Discounted Cost

Resulting cost when the real cost is discounted by the real discount rate or when the nominal cost is

discounted by the nominal discount rate

Discount Rate

Factor reflecting the time value of money that is used to convert cash flows occurring at different

times to a common time

NOTE This may be used to convert future values to Present Day Values and vice versa.

Nominal Discount Rate

Rate used to relate present and future money values in comparable terms taking into account the

general inflation/ deflation rate

Real Discount Rate

Rate used to relate present and future money values in comparable terms, not taking into account the

general or specific inflation in the cost of a particular asset under consideration

Net Present Value

Net Present Value is the sum of the discounted future cash flows. Where only costs are included this

may be termed Net Present Cost (NPC)

Present Day Value

Monies accruing in the future that have been discounted to account for the fact that they are worth

less at the time of calculation

Sensitivity Analysis

Test of the outcome of an analysis by altering one or more parameters from initial value(s)


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Residual Value

Value assigned to an asset at the end of the period of analysis.

0.7 Relationship with ISO 14040

It is important to note that the ISO 15686 definition of the term ‘life cycle’ differs from that

used in the environmental standard, ISO 14040. The latter adopts a broad ‘cradle to grave’

definition of life cycle, whereas the ISO 15686 definition can represent either ‘cradle to

grave’ or a shorter economic analysis timeframe driven by the specific client or project

needs.

The ISO 14040 definition of life cycle feeds into that of life cycle assessment (LCA) as

follows:

Life cycle

Consecutive and interlinked stages of a product system, from raw material acquisition or generation

of natural resources to the final disposal.

Life cycle assessment

Compilation and evaluation of the inputs, outputs and the potential environmental impacts of a

product system throughout its life cycle.

This methodology aligns with the ISO 15686 definition of life cycle. However, for the

purposes of consistency, users applying LCC to evaluate the outcomes of an LCA analysis

may wish to align with the broader ISO 14040 definition of life cycle. Further specific

public sector guidance on the appropriate parameters for carrying out an LCC analysis is

provided in the guidance note that accompanies this methodology.

0.8 Companion documents

This methodology is accompanied by a guidance note and a set of case studies of the

common use of LCC in Europe. The guidance note is aimed at public sector clients and

provides an introduction to LCC along with guidance on why it should be used, its benefits,

the information to be gained from it, and its relationship with the EU procurement

framework. The case studies are included as an appendix to the guidance note.


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1 STEP 1: Identify the main purpose of the LCC analysis

1.1 Purpose of this step

LCC is a versatile technique capable of being applied for a range of purposes and atdifferent stages in the project or asset life cycle. The purpose of this step is to clearly

identify the purpose of the proposed LCC analysis and to gain an understanding of how it

can be appropriately and successfully applied and of the outcomes that can be expected.

1.2 Purposes for which LCC may be employed

The purposes for which LCC may be employed can be divided into, in two broad

categories:

As an absolute analysis, when used to support the processes of planning, budgeting and

contracting for investment in constructed assets

As a relative analysis, when used to undertake robust financial option appraisals, for

example in relation to potential acquisition of assets, design approaches or alternative

technologies.

More specifically, LCC can be used to support decision-making in a number of ways:

In assessing the total cost commitment of investing in and owning an asset, either over

its complete life cycle (“cradle to grave”) or over a selected intermediate period

By improving understanding of the total cost of an asset, particularly by construction

clients, and improving the transparency of the composition of these costs

By facilitating effective choices between different means of achieving desired

objectives, for example reducing energy use or lengthening a maintenance cycle

By helping to achieve an appropriate balance between initial capital costs and future

revenue costs

In helping to identify opportunities for greater cost-effectiveness, for example selection

of components with a longer service life or reduced maintenance requirements

As a tool for the financial assessment of alternative options identified during a

sustainability analysis, for example components with less environmental impact or

HVAC systems with greater energy efficiency

Overall, by instilling greater confidence in decision-making in a project.

LCC can be employed throughout or at different stages of the life cycle of an asset or a

project to invest in construction; this is considered in detail at step 2.

Some examples of common applications of LCC follow below in this section to furtherillustrate these points.

1.3 Typical applications of LCC

Table 2 below illustrates how LCC can be applied in a variety of circumstances, with

examples drawn from a building development. The same principles apply in an

infrastructure or engineering context. The successive stages in the whole life cycle of a

scheme and the related need for decisions are considered in more detail in section 2

following. More detailed examples are provided in the Guide that accompanies this

methodology.


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Table 2: Typical applications of LCC

Context and need Typical application of LCCDuring investment planning, clientswill need to understand the full costimplications of operating as well asbuilding the scheme, to establish itsessential viability.

The analysis will be based on approximatedata, typically historical information fromsimilar projects, but sufficient for budgetingand option ranking to allow a decision onwhether to go ahead, to reduce the schemeor stop.

During the early stages of schemedesign, decisions will be required onthe fundamental elements –structure, envelope, services,finishes

The analysis can draw on feasibility studiesand pre-project professional advice, as wellhistorical information, to support decisions onthe key features of the scheme – its size,scope, method of construction and operation.

By detail design stage, the essential

cost parameters of the scheme willbe determined but decisions will stillbe required on details and whether,finally, to commit to construction.

Information can now be fed into the analysis

based on a clear view of all primary elementsof the scheme and access to related cost,service life and maintenance data frommanufacturers’ specifications, as well assimilar projects and national price books.This allows a detailed LCC breakdownconfirming the viability of the scheme andappraisal of detailed design options.Sensitivity and risk analyses may also becarried out.

Detailed design also requires finalselection of materials, componentsand systems. Potentially, similar

decisions will subsequently berequired in the event of theirreplacement during operation andmaintenance

LCC analysis can be focused on the specificcomponent or system with the benefit ofrelated cost, service life and maintenance

data from manufacturers’ specifications, aswell as from similar projects and nationalprice books. The main focus will be onoption evaluation, ranking and selection.

During the operation of thecompleted asset refurbishment andrenewal of some elements might berequired, driven by (for example):High operational costsHigh energy consumptionObsolescence (for example:physical, technical, economic,social)

Change in use of the assetComponents or systems reachingthe end of their service life

LCC can be applied in supporting selection ofthe most appropriate refurbishment orrenewal option, at either an asset orcomponent level. The analysis can be basedon historic or benchmark data, or on detaileddata derived from manufacturers’specifications and comparable cost-in-usedata. It is essential that the analysis takesinto account the impact on interdependent

systems and the overall asset.

1.4 The need for clarity of objectives

The different purposes for which LCC may be employed, and the different stages of the

asset life cycle at which it is used, imply the need for different levels of detail and accuracy

in the process, and in the inputs and outputs. For example, if LCC is employed to support

an early budgeting process, all relevant costs must be considered and the analysis may be

based on approximate data such as historic benchmark information. As the LCC analysis is

subsequently refined during the detailed design stages, further detail will be required on all

cost items, along with robust service life and maintenance data. The process may also need


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to support auxiliary outputs such as an estimate of resources or a reporting schedule to

provide all necessary support for decision-making.

If the primary purpose is to appraise options, the process of iteration will involve refining or

eliminating the available alternatives as they are measured against project objectives and

budget constraints. This process will include identification of those cost elements that do

not have a significant impact on the overall LCC or which do not vary between the

alternatives. These elements can be then be eliminated from further consideration.

Accordingly, clearly defining the objectives of a proposed LCC analysis must be seen as an

essential first step in ensuring that it will be fit for the user’s purpose.

1.5 The ingredients for success

Successful application of an LCC approach requires:

A team approach incorporating all key players in a project

Integration of the LCC exercise into the whole investment decision-making process

through the conception, design, construction and operation of a facility

Recognition that the robustness of the outputs of the LCC exercise is highly dependent

on the level of detail and certainty in the cost and time inputs used

Clear definition of scope and consideration of all relevant parameters (note that scoping

issues are covered in Step 2)

Recognition of the limitations of the techniques employed, leading to the proper exercise

of professional judgement.

1.6 At the end of Step 1

At the end of Step 1 the user will have developed:

A clear and comprehensive statement of the purpose of the proposed LCC analysis An understanding of how LCC analysis can be appropriately and successfully applied

and the outcomes that can be expected.


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2 STEP 2: Identify the initial scope of the LCC analysis

2.1 Purpose of this step

In step 1 the broad purpose and outcomes of the LCC exercise were identified. For theoutcomes to be achieved it is also important to identify the scope of the exercise, including

the stage(s) in the asset life cycle at which it is undertaken, the boundaries of the analysis

and whether there are any specific inclusions or exclusions.

2.2 The scale of application of LCC

LCC analysis may be undertaken to support a project to invest in:

A single complete constructed asset that comprises a usable facility such as a building or

civil engineering structure

An individual component , material or system within such an asset

A portfolio comprising a number of assets

For clarity, this methodology assumes the scenario of a project to construct and use a single

asset, but the same principles and basic processes apply whatever the scale of application of

LCC.

The scale of application for a proposed LCC analysis will be defined by the client, in the

light of the objectives defined as discussed in section 1 above.

2.3 Stages in the life cycle of an asset

For the purposes of this methodology the life-cycle of an asset is divided into the following

stages:

Investment planning, pre-construction

Design, construction

Operation, maintenance

End of life / disposal

Activities in the investment planning / pre-construction phase might typically include:

Business case preparation

Acquisition of site(s) or of existing asset(s)

Professional consultancy

Inspections and surveys

Arranging finance

Assembling the project team / consortium Procurement planning

Activities in the design and construction phase might include:

Scheme design

Detailed design

Site clearance

Placing contracts for construction

Construction of the fabric

Fitting out

Commissioning and handover

Landscaping

Activities in the operation and maintenance phase might include:


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Employing an FM team or placing an appropriate contract

Placing contracts for energy supply and other utilities

Arranging insurances and compliance with regulatory requirements, eg inspections

Planning and carrying out pre-planned (cyclical) maintenance and replacements

Carrying out unplanned (responsive) maintenance and replacements Planning and carrying out pre-planned refurbishment and/or adaptation (such works may

be better considered as separate projects subject to their own LCC considerations)

Cleaning

Redecoration

Grounds maintenance.

Activities in the end of life/disposal phase might include:

Sale of asset

Change of use of asset

Demolition

Site and land clearance and clean up Recycling of materials

A proposed LCC analysis might take place over one or more or all of these stages, as

discussed below. Its purpose must be defined by the client, in the light of the objectives

defined at step 1.

2.4 Use of LCC through successive stages.

LCC analysis can be used either as a one-off intervention to a project or, in a broader

context, to inform different decisions at different stages of the project or asset life cycle. In

the latter case, input data is progressively refined as the project moves through successive

stages. Accordingly, as calculations are based on increasingly detailed and reliable data andinitial assumptions are tested and validated, early strategic decisions are confirmed and

subsequent decisions taken at increasing levels of detail.

2.4.1 Investment planning / pre-construction

Decisions at planning / pre-construction stage are of a strategic nature relating to the

essential features of the proposed project, with data typically input at a low level of detail.

They typically cover the following considerations:

The essential features of the proposed scheme

Methods of investment appraisal

Finance – costs, budgets, cash flow, funding sources

Procurement policy and methods

Balance between economic, technical and sustainability considerations

Risk management strategies and techniques

Key project drivers and overall priorities.

The application of LCC at this stage in the in the project might include:

Identification of the purpose(s) of using LCC, both at this stage and in subsequent stages

Incorporating LCC requirements into business case, project documentation and supply

chain terms of reference

Identification of methods of analysis, required outcomes and reporting formats

Identification of required analysis period and/or design life for the proposed facility

Consideration of cost drivers, including capital v operating cost priorities

Use of LCC as an assessment criterion in project approval/gateway processes


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Use of LCC in assessing initial strategic project options such as whether to refurbish or

build new.

2.4.2 Design and construction

Design and construction is a broad stage with design decisions taken successively throughthree levels:

Scheme level, fixing the basic physical characteristics of the facility

System level, deciding the major installations and assemblies

Detail design.

The level of detail in the LCC analysis typically increases progressively though these levels

and its purpose and implementation should be kept under review as it is reiterated. LCC

considerations through this stage typically include:

LCC impact of high level design decisions such as format, composition, orientation and

layout of the proposed asset

Selection of components, materials and systems and assessment of their costs over thelife cycle (or part thereof)

Life cycle costing of sustainability options identified as part of a sustainability

assessment process

Assessment of future operating costs of the facility and its constituent parts

Contractual framework, both for construction and future operation and maintenance

Resource implications during the operational stages

Need for and ease of functional reconfiguration / adaptation during operation

Any planned replacement / refurbishment during operation

Ease of carrying out future maintenance, replacement and refurbishment, including

health and safety implications

Impact of future LCC works on the use and users of the asset

2.4.3 Operation and maintenance

The opportunities and need for LCC analysis continue into the operation and maintenance

stage and might typically relate to:

Cost and performance drivers during operation and maintenance

Assessment of options in relation to component replacements, refurbishment, adaptation

Financial framework and funding of LCC works, including use of sinking funds

Denial-of-use costs, whether loss of amenity or contractual penalties (such as in PPP or

other FM contractual payment mechanisms)

Strategies and planning for operation and related cost models:o FM

o Energy

o Other utilities

o Cleaning

o Waste disposal and recycling

Strategy and planning for maintenance, repair and replacement works:

o Contractual framework and responsibilities (for example in-house delivery or

outsourcing of some/all activities)

o Maintenance planning and management systems (including use of condition-based

monitoring)

Collection and use of feedback data

Risk allocation for operation, maintenance and finance costs


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2.4.4 End-of-life / disposal

LCC considerations at the end-of-life stage might include:

Strategy for disposal, including methods, costs, residual values

Evaluation of alternative uses of the facility

Evaluation of options for demolition and site / land clean up, including methods, costs

Strategy for salvage and recycling – opportunities, costs, potential value

Collection and use of feedback data

2.5 Identification of analysis boundaries

It is important during the early scoping exercise to identify the broad boundaries of the LCC

analysis, including:

Whether the analysis period is to include the entire asset life cycle or a defined part

thereof (see Step 3 below)

What costs (and revenues) are to be included or excluded from the analysis (for example

the client’s contractual or financial interest in the asset may require certain costs to beexcluded)

Whether there are particular project, contractual, regulatory or economic issues that will

influence key criteria (such as analysis period, method of economic evaluation) that are

to be defined in future steps.

2.6 Identification of analysis outputs

The required outputs and reporting format of the LCC analysis should be agreed in broad

terms at this stage. Clients may require the detailed analysis and/or the summary findings

to be presented in a particular format to suit their internal reporting processes or those of an

external regulatory or funding body. Early identification enables the user to address theseissues before the analysis has been undertaken, thereby eliminating unnecessary reworking

of reports at a later stage. LCC consultants often use in-house software with standard report

formats that might require amendment. Note that detailed reporting issues are considered in

Steps 14 and 15 of this methodology.


At the end of step 2, the user will have developed a clear understanding of:

The scale of application of the LCC exercise

The stage(s) of the project or asset life cycle over which it is likely to be undertaken

The scope and nature of the issues and information likely to be relevant.

Any specific client reporting requirements that require early consideration.


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3 STEP 3: Identify the extent to which sustainability – and

specifically environmental – analysis relates to LCC

3.1 Purpose of this stepEnvironmental sustainability is becoming a key consideration in any long term assessment

of constructed assets. The relationship between LCC and sustainability assessment and the

extent to which the latter forms an input to the LCC analysis is defined at this step.

3.2 Assessing sustainability

Practitioners recognise three fundamental and interlinked sets of issues within the

‘sustainability’ agenda:

Environmental – relating typically to air quality, land use, use of natural resources (raw

materials, energy, water, waste etc), transportation, biodiversity, cultural heritage, etc.

Social – relating typically to access, amenity, user comfort and satisfaction, community

health and welfare

Economic – relating typically to opportunities for employment, skills development,

local businesses including SMEs,

Some sustainability issues are difficult to measure and to incorporate into a LCC analysis.

However, LCC practitioners widely accept that the environmental impact associated with

constructed assets can be significant and should always be considered. A range of

approaches to assessing environmental impact are available to suit the type of asset, the

aspects of the environment that are of concern and the particular parameters that are of

interest. The following are the most frequently used:

Life Cycle Assessment (LCA) – LCA addresses the environmental aspects and potential

environmental impacts (e.g. use of resources and the environmental consequences of

releases) throughout a product's life cycle from raw material acquisition through

production, use, end-of-life treatment, recycling and final disposal

Environmental Impact Assessment (EIA) – a process for informing decision-makers

of the local environmental consequences/effects potentially caused by different project

options

Multi-Criteria Analysis (MCA) – a process that initially identifies a set of goals or

objectives and then seeks to identify the trade-offs between those objectives for different

options. The 'best' environmental solution is identified by attaching weights (scores) to

the objectives.

While a number of approaches to assessing environmental impact are available to suit

individual requirements, LCA is one of the most versatile and widely recognised in

construction and is referred to in this methodology. It is also the only approach that is the

subject of International Standards (ISO 14040 and ISO 14044).

To be properly comprehensive, an environmental impact assessment of a constructed asset

must extend to the manufacturing process and transport of materials and components.

3.3 Measures employed in LCA

Environmental impact is caused primarily by the consumption and/or transformation of

materials and energy. Accordingly LCA measures the consumed and emitted flows (that is,

raw material and energy consumption, and emissions to air, water, soil) over the whole life

cycle of the asset from raw material acquisition through production, use, end-of-life


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treatment, recycling and final disposal of the asset. This compilation of inputs and outputs

is called Life Cycle Inventory (LCI).

The LCI is the basis for a later analysis and potential assessment of the environmental

effects related to the product or process. This aggregation of the many single resources and

emissions is then translated into indicators about the potential impacts on the environment,

health, and use of natural resources. This step is called Life Cycle Impact Assessment

(LCIA). In general, this process involves associating inventory data with specific

environmental impact categories and category indicators. The collection of indicator results

(LCIA results) or the LCIA profile provides information on the environmental issues

associated with the inputs and outputs of the system assessed.

Life Cycle Impact Assessment (LCIA) methods can be grouped into two families: classical

methods determining impact category indicators at an intermediate position of the impact

pathways (e.g. ozone depletion potentials) and damage-oriented methods aiming at more

easily interpretable results in the form of damage indicators at the level of the ultimate

societal concern (e.g. human health damage). Although users may choose to work at eitherthe midpoint or damage levels, a current tendency in LCIA method development aims at

reconciling these two approaches. Both of them have their merits, and optimal solutions can

be expected if the 'midpoint-oriented methods' and the 'damage-oriented methods' are fitted

into a consistent framework.

Because there is no single accepted method carrying out LCA, the European Commission

has provided a standardisation mandate M/350 to CEN in order to establish a set of specific

LCA rules for assessment of environmental performance of buildings and construction

products. The rules are to be based on the generic ISO standards 14040, 14044 and 14025

for Environmental Product Declarations and they are also in line with the building

construction sector specific standards under development in ISO. As a consequence CENhas established a technical committee CEN/TC350 “Sustainability of Construction Works”

to fulfil the work specified in the mandate M/350.

Note: Where the term LCA is used in the following sections it should be taken to

encompass all environmental sustainability assessment methods.

3.4 Interrelationship between LCC and sustainability analysis

Whilst LCC and LCA are two distinct and different processes that have developed and are

practised as separate disciplines in the construction industry, there are many parallels and

interrelationships between the two. For example, both:

Are concerned with assessing the long term impacts of decisions Require analysis of an often diverse range of inputs

Use similar data on inputs of materials and energy

Take into account operation and maintenance

Consider opportunities for recycling vs. disposal

Provide a basis for rational decision making, particularly in appraising options.

However, the two disciplines differ in the basis of the resulting decisions:

LCC combines all relevant costs associated with an asset into outputs expressed in

financial terms as a basis for making investment decisions

LCA enables decisions to be made on the basis of potential environmental impacts by

scoring and rating on environmental criteria. Whilst costs can be firmly attributed to


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some environmental factors there is currently no widely agreed methodology for others

and some cannot be quantified at all in cost terms.

As a result LCC and LCA do not necessarily produce a common output. Nevertheless

environmental impact assessment has a key place in overall long term decision-making and

consideration should be given to how to integrate it with the LCC process at the earliest

stages.

3.5 The use of LCA with LCC

As discussed above, in LCC the primary driver in decision-making is cost and LCA informs

decisions on the basis of potential environmental impacts. The use and sequence of LCC

and LCA will depend on the priorities of the decision-maker. The range of approaches

might cover, for example:

Use of LCC and LCA as two of the criteria in the evaluation of a single investment

option (such as the decision to construct an asset), where other evaluation criteria might

include functionality, aesthetics, speed of construction, future investment returns etc. Use of LCC and LCA as two of the criteria in the evaluation of a number of alternative

investment options (either entire constructed assets or specific components, materials

or assemblies within them)

Use of LCC to provide a financial/economic evaluation of those sustainability impacts

that have a widely agreed and readily calculated monetary value

Use of LCC to provide a financial/economic evaluation of alternative options identified

in a LCA assessment

Use of LCA as a means of identifying alternative options with a good environmental

performance and then carrying out a LCC analysis on those options only

Use of LCC to select cost effective options, then making a final decision in the light of a

process of LCA carried out on those options only.

Thus it can be seen that LCC and LCA can either be used alongside each other in a broader

evaluation process, or either process can form an input into the other.


At the end of step 3 the user will have developed a clear understanding of:

The relationship between sustainability assessment and LCC

The extent to which the outputs of a sustainability assessment will form inputs into the

LCC analysis

The extent to which the outputs of the LCC analysis will feed into a sustainability

assessment


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4 STEP 4: Identify the period of analysis and methods of economic

evaluation.

4.1 Purpose of this stepThe selection of the appropriate period of analysis is fundamental to the outcome of a LCC

exercise. In step 2 the User identified the likely broad timescale of the LCC exercise. In

this step, the timescale over which the analysis takes place is confirmed as the ‘period of

analysis’.

4.2 Period of analysis

The period of analysis is formally defined in ISO15686 Part 5 as follows:

“The length of time over which an LCC assessment is analysed. This period of analysis

shall be determined by the client at the outset (e.g. to match the period of ownership) or

on the basis of the entire life cycle of the asset itself.”ISO 15686 Part 5 provides further definitions as follows:

Life Cycle as “Consecutive and interlinked periods of time between a selected date and

the disposal of the asset, over which the criteria (e.g., costs) are assessed. This period

may be determined for the analysis (e.g., to match the period of tenancy or ownership)

or cover the entire life cycle. The life cycle period shall be governed by defining the

scope and the specific performance requirements for the particular asset.”

Entire Life Cycle as “Consecutive and interlinked periods of time between a selected

date and the end of service life of the asset, including the end of life period.”

It should be noted that the ISO 15686 definition of life cycle differs from that in the

environmental standard, ISO 14040. The latter adopts a broad ‘cradle to grave’ definitionof life cycle, whereas the ISO 15686 definition can represent either ‘cradle to grave’ or a

shorter economic analysis timeframe driven by the specific client or project needs. Users

should confirm with the client which definition is to be adopted for their LCC analysis.

The decision on the appropriate analysis period for a LCC exercise may be driven by a

number of factors relating to the client, the project and/or asset, and the financial, legal and

regulatory framework in which they operate. Key drivers might include:

Design life of the asset

Project duration (for example PPP projects typically last for 20-30 years)

Period of economic interest in the asset (for example lease period)

Financial drivers (for example investment requirements, loan periods) Projected refurbishment/remodelling periods

Regulatory requirements (for example treasury guidance may stipulate analysis period)

Business planning cycle

Client requirement to adopt the ISO 14040 environmental definition of ‘life cycle’

The selected analysis period can have a fundamental impact on the outcome of a LCC

exercise and it is essential that the appropriate consideration is given to it. In particular, the

potential effects of selecting a particularly long or short analysis period should be

understood. Selection of a longer analysis period introduces higher levels of risk into the

analysis, as the long term impacts of issues such as inflation, future need for and use of the

asset, component maintenance and replacement requirements (i.e. service life) and system

obsolescence become more difficult to predict over time. This is not to suggest that users


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should not carry out LCC exercises over longer time periods, rather that the increased risks

need to be adequately understood and accounted for.

Users should also be aware of the impact of the chosen discount rate (see below) when

applied over different analysis periods. The longer the analysis period, the greater the

impact that the chosen discount rate will have on future costs. Conversely, the shorter the

analysis period, the less effect discount rates will have on the analysis outcome.

4.3 Asset and component life

In order to identify the appropriate analysis period users may need to make an assessment

of the expected life of the asset or its constituent parts. The first distinction that users

should understand is that of ‘design life’ and ‘service life’. ISO 15686 Part 1 defines the

terms as follows:

Service life: period of time after installation during which a building or its parts meets or

exceeds the performance requirements.

Design life: intended service life, or expected service life, or service life intended by the

designer.

In practice, the term “life” when applied to a constructed asset can be defined in a number

of ways depending on the interests and objectives of the user, as follows:

Physical life (from construction to demolition or replacement). Every asset has a

predicted length of life at the end of which a physical collapse is possible. However

most assets never reach that point and are demolished or replaced beforehand, generally

due to economic obsolescence. Note that physical life corresponds to the ISO 15686

definition of ‘service life’.

Economic life (from construction to economic obsolescence). Economic obsolescencehappens when the further use of an asset is no longer the most economic solution among

alternatives.

Functional life (from construction to the point when the asset ceases to function for its

intended purpose). An asset reaches the end of functional life when it can no longer

function for the purpose for which it was intended.

Technological life (from construction to the point when the asset is technologically

obsolete). End of technological life occurs when an asset, typically a system or

component, is no longer technologically equal to or better than available alternatives.

Social / legal life (from construction to the point when replacement is required for social

or regulatory reasons). An asset reaches the end of its social or legal life when

requirements other than economic dictate replacement or change, e.g. health and safetyor legislative issues.

Contractual / ‘duration of interest’ life (for any period of time during the duration of

the physical life of an asset). This period of analysis covers the length of a contract for a

particular service, e.g. construction, operation, etc.

Arbitrary life (length of time e.g. 25, 30, 50 years), assumed due to national practice,

local best practice, client’s stipulation, etc.

It can be seen from the above range of potential definitions of life that the period of analysis

for a LCC exercise can often be shorter than the physical life of an asset, that is, from

“cradle to the grave”. The ‘period of analysis’ must therefore be specifically defined for

each LCC exercise.


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4.4 Discounting

4.4.1 The purpose of discounting

Discounting is a widely used technique for comparing costs and revenues occurring at

different points in time on a common basis, normally the present time. It is based on theprinciple that a sum of money to hand at the present time has a higher value than the same

sum to hand at a future date, because of the earning power of that sum in the interim.

Discounting to present value makes an adjustment to the future costs of an asset that takes

account of inflation and the real earning power of money, allowing them to be compared

and evaluated on the same basis as costs incurred at the present.

The need to discount depends on the use to which the LCC analysis will be put. It is

necessary only where a series of costs over time has to be put onto a common basis for the

purpose of a decision, not where the objective is simply to project annual costs on a year by

year basis. Therefore when carrying out a LCC evaluation of two or more options with

different cost profiles over time it is likely that discounting will need to be applied, whereas

it may not be necessary if the aim is simply to prepare a cost profile for one option alone.

4.4.2 The effect of discount rates

A decision not to discount, that is, to apply a zero rate, implies that the timing of a cost (eg

for repair or renewal) is immaterial and disregards the earning power of money. However,

use of a zero rate presents the best case for spending a greater sum up front (i.e. capital

costs) in order to generate greater savings through the analysis period (e.g. operating,

maintenance, energy costs). It can therefore be argued that a zero discount rate should be

applied to all public sector investments intended to leave a lasting legacy for future

generations.

Conversely, a high discount rate will present options with low up-front costs as appearing

more desirable and it can be argued that this has the effect of sacrificing the interests of

future generations to those of the present decision-makers. However, future uncertainties

and external influences unrelated to the asset (eg budgetary constraints or changed political

priorities) may have an impact on the timing or extent of future costs. It can therefore be

argued that this represents an argument for affording future costs less weight in decision-

making and hence for discounting.

Further guidance on the selection of the appropriate discount rate is provided below.

4.4.3 The treatment of inflation

The discount rate is the investment premium over and above inflation and as such is a

separate concept and distinct from it. There are two possible approaches to dealing with

inflation:

Using a ‘nominal’ discount rate, that is a rate that is not adjusted to remove the effects of

actual or expected inflation. This means that inflation predictions are built into forecast

costs and prices

Using a ‘real’ discount rate, that is a rate that has been adjusted to remove the effect of

actual or expected inflation. This means that future costs and prices are estimated at

present day (‘real’) prices and inflation can be dealt with separately.

If inflation rates for all costs in the analysis are approximately equal, it is common practice

to exclude inflation from the LCC analysis (i.e. to adopt a ‘real’ discount rate). However, if


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the analysis includes commodities subject to widely differing rates of inflation, for example

energy prices and labour rates, inflation would have to be included (i.e. using a ‘nominal’

discount rate).

Because constructed assets typically have long service lives and it is difficult to predict

inflation in the long term, it is generally recommended to carry out LCC analyses on using

real costs and discount rates. It is further often recommended that results should be tested

by applying at least two real discount rates, including one relatively lower rate, and

appraising the difference in outcomes (see Step 13 guidance on sensitivity analysis).

4.4.4 Selecting the discount rate

Selecting the most appropriate discount rate is critical to the success of an LCC exercise. In

the private sector, selecting the rate can be a highly judgemental process with reference to

the financial status of the client and the circumstances of the particular project, and in

practice rates can vary widely. Key considerations will be the cost of capital, the perceived

level of project risk and the opportunity cost of capital (i.e. the level of return that could begenerated by investing the capital elsewhere).

In the public sector, national ministries of finance generally specify the discount rates to be

used in the economic analysis of publicly funded projects. These typically fall into the

range of 3 to 5%. The rate may also be assessed on a case by case basis by reference to:

The opportunity cost of capital

The societal rate of time preference

The cost of borrowing funds.

The ‘opportunity cost of capital’ is the cost of foregoing an alternative investment. This

approach assumes that finance for public sector projects is withdrawn from private savings

and which would otherwise have gone into private investment. Hence the discount rate is

equated to the pre-tax rate of return available to private capital.

The ‘societal rate of time preference’ is the interest rate that reflects a government’s

judgment about the relative value which society as a whole assigns (or which the

government feels it ought to assign) to present versus future consumption. The societal

time preference rate is not observed in the market and bears no relation to the rates of return

in the private sector, interest rates, or any other measurable market phenomena.

The rationale of the ‘Cost of Borrowing Funds’ approach is that the interest rate should

match the rate paid by government for borrowed money. This approach is favoured by

many agencies and is supported by the argument that government bonds are in direct

competition with other investment opportunities available in the private sector.

Some advocate use of a zero interest rate in the public sector, arguing that when tax monies

(eg road tax) are used, such funds are “free money” because no principal or interest

payments are required. A counter-argument is that zero or very low interest rates can

produce positive cost/benefit ratios for even very marginal projects and thereby take money

away from more worthwhile projects. A zero interest rate also fails to discount future

expenditure, making tomorrow’s relatively uncertain predicted costs as significant in the

decision as today’s known costs.


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4.5 Methods of economic evaluation

A number of widely used financial analysis techniques are available for the assessment of

alternative investment options. Using two or more techniques together provides a broader

picture of value implications.

4.5.1 Net Present Value (NPV), Net Present Cost (NPC)

The NPV is the sum of the discounted future cash flows, both costs and benefits/revenues.

Where only costs are included this may be termed Net Present Cost (NPC).

NPV is a standard measure in LCC analyses, used to determine and compare the cost

effectiveness of proposed options. It can be applied across the full range of construction

investments, covering whole investment programmes, assets, systems, components and

operating and maintenance models. The costs and revenues/benefits to be included in each

analysis are defined according to its objectives. For example, revenues from recycling of

materials or from surplus energy generation are typically included in a LCC analysis of

alternative sustainability options.

4.5.2 Payback (PB)

The PB period is the measure of how long it takes to recover initial investment costs and is

a useful basis for evaluating alternative investment options. It may be calculated using

either real (non-discounted) values for future costs, that is ‘Simple PB’, or present

(discounted) values, that is ‘Discounted PB’. PB in general ignores all costs and savings

after the payback point has been reached and it is possible that an investment with a short

PB is a poorer option than one with a longer payback over the entire period of analysis.

PB is a useful technique for assessing whether additional investment in, for example, lower

energy plant, is worthwhile. It enables users to weigh the additional capital costs against

the time it takes for these costs to be recouped through savings or income during the

operational period. This may be a useful means of judging whether an investment

represents good value for money, although the subjective nature of the value for money

assessment may make it inappropriate for some public sector investment decisions.

4.5.3 Net Savings (NS), Net Benefit (NB)

NS/NB is the present value of savings/benefits in the operation phase less the present value

of the additional investment costs to achieve them. It provides a measure of cost-

effectiveness and of the benefits to be achieved from investment options. NS/NB greater

than 0 indicates positive cost-effectiveness.

4.5.4 Savings to Investment Ratio (SIR)

The SIR is a measure of the cost-effectiveness of a proposed investment (an SIR greater

than 1 is positive) and can be used to prioritise and select investment options.

4.5.5 Adjusted Internal Rate of Return (AIRR)

The AIRR is a measure of the annual yield from a project over the period of analysis taking

into account reinvestments of interim receipts, indicating projects with greater net savings.

An AIRR greater than the minimum acceptable rate of return (ie the discount rate) is

positive.


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4.5.6 Annual Cost and Annual Equivalent Value (AC or AEV)

The AC or AEV is a uniform annual amount that, when totalled over the period of analysis,

equals the total net cost of the project taking into account the time value of money over the

period. It is used to compare investment options where the natural replacement cycle

cannot easily be directly related to the period of analysis. The lowest AEV indicates the

lowest cost option.

4.6 Guidance on which evaluation technique(s) to use

Further guidance on which evaluation techniques are most appropriate in a public sector

context is provided in the Guidance Note that accompanies this methodology.

4.7 Taxation issues

Fiscal considerations can be highly significant in LCC analyses, particularly in the private

sector, with tax efficiency a major objective in designing investment portfolios, finance

arrangements and individual projects. Taxation is a complex area, varying between

member states. Accordingly it is important at this step to develop a strategy for managing

fiscal issues, seeking at the earliest stage the specialist professional advice which is

available in this area. Such a strategy should be designed to minimise the tax burden on the

project by identifying appropriate innovative and practical tax and business solutions.

Key considerations in the strategy include:

The tax relief or offsets which may be available against certain costs in the overall CBS,

e.g. typically for repairs and maintenance, which would tend to favour options with

lower initial costs

Similarly the tax penalties which might apply to the use of certain materials or have an

indirect impact, e.g. through higher energy costs.

Tax can also represent an area of risk, for example in:

The probability of environmentally inefficient structures attracting current or future

environmental taxes

The possibility of tax rates changing.

Value added tax (VAT is subject to similar considerations. Both the rate and accounting

methods vary between member states and specialist advice is again likely to be essential.


At the end of Step 4 the user will have: Identified and confirmed with the client the period of analysis and the considerations

governing its choice

Identified and confirmed with the client the appropriate technique(s) for assessing

investment options, including the discount rate(s) to be used and the implications

therein.


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5 STEP 5: Identify the need for additional analyses (risk/uncertainty

and sensitivity analyses)

5.1 The purpose of this stepRisk and uncertainty analysis is a body of theory and practice which has been developed to

help decision-makers assess their risk exposure and attitudes in a systematic manner. At

this step the user considers how and why it can be applied in conjunction with LCC

analyses to support decision-making and in particular, which risk assessment methodologies

will be most appropriate.

5.2 Risk and uncertainty in LCC

Ownership, investment and occupation of constructed assets are by nature long-term

activities and as such are characterised by a range of uncertainties, principally in the value

and timing of future costs and revenues. Within this context, LCC is a forward lookingprocess that requires predictions of these variables to be made in order that robust decisions

can be taken. Consequently, certain risks are inherent in the LCC assessment process,

namely:

That the total life cycle costs in a given period exceed those calculated, and;

That the life cycle cost profile over a given period differs from that predicted (e.g. the

total costs may be the same, but the distribution of those costs over time differs from

that predicted).

These key risks can arise as a result of variability in one or more of the predicted values or

assumptions in the LCC model (see Sec.5.4 below).

While robust assessment of the key cost and time variables can help reduce the risksinherent in the LCC process, the fact that LCC is concerned with predicting future costs and

activities means that an element of risk will almost always be built into the calculations. It

is therefore important that clients are made aware of this issue and of the steps that can be

taken to quantify and in some cases mitigate the risks.

Often, the identification and assessment of LCC related risks can have a significant

influence on decision-making process, with a resulting impact on the LCC of a project –

examples are given in table 3 below.

Table 3: Potential impact of risk on decision-making

Examples of risks identified Possible decisions taken in response

Risk of more demandingenvironmental legislation

Selection of higher capital cost HVACsystem with improved environmentalperformanceSelection of lower capital cost HVACsystem with shorter life and due forreplacement in short period of time

Risk of LCC increases and/ordisruption due to high cost/quantitycomponents requiring earlyreplacement

Selection of alternative components withlonger service life or improved warrantiesImprove planned maintenance regime toprevent early failures

Risk that labour costs will rise in

excess of inflation allowances inmodel

Selection of less labour intensive

materials and systems (e.g. requiring lesscleaning and maintenance)


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Increase inflation allowances in model.Risk of increased land-fill/waste taxes Selection of longer-life components in

order to minimise wasteSpecify greater proportion of recyclablematerials

5.3 Managing risk/uncertainty

The management of risk is fundamentally a three stage process:

Identifying the risk

Assessing the risk in terms of its likelihood and impact

Taking appropriate action in response, which might variously be to accept, mitigate,

transfer or avoid the risk.

The extent to which the above process is applied and whether it is undertaken for LCC in

isolation or as part of a wider, formalised risk management process is a matter of judgement

for the client in the light of the scope and complexity of the project. This decision should

be taken at this step in the LCC methodology. For a major investment a risk management

plan should be formally established with clear objectives and success criteria, proper

planning and resourcing, and effective management and control.

The risk management plan should be progressively updated as a project moves through its

stages. The overall process is illustrated in figure 3 below.

Figure 3: Risk management cycle.

PeriodicUpdate

5.4 Identifying causes of variability in the LCC analysis

A number of common risk identification methods can be used for identifying potential

causes of variability in the LCC analysis including:

Accessing relevant databases, where available

Obtaining feedback from past projects


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Drawing out the knowledge and experience of individuals within the team, eg by

‘brainstorming’ techniques

Conducting interviews

The ‘Delphi’ method, gathering information from project participants by email or post

Checklists of variability factors commonly associated with particular tasks.

Common causes of variability in LCC include:

Capital costs (actual v predicted)

Operational costs, including maintenance, FM, energy, component replacements

Costs of refurbishment/upgrading

Disposal costs

Future levels of inflation (labour and materials) underpinning the above costs

Interest rates (in relation to loan payments)

The service lives of the components, systems and materials that make up the asset

The extent and timings of planned (cyclical) maintenance and refurbishment works

required The extent and timings of unplanned (responsive) maintenance required

Energy consumption levels

Changes in the use of the asset

Obsolescence / technological development

Change in the fiscal regime

New legislation, for example on sustainability issues

Only risks that are strictly relevant to the LCC exercise in hand should be considered.

Some risks such as future obsolescence and legislative changes are almost impossible to

assess and the decision may be taken to discount them.

Further guidance on the prediction of service lives of constructed assets and theircomponents, and the factors affecting service lives is provided in ISO 15686 Part 1.

During this risk identification process initial views may be formed on the probability of

occurrence, impact, ownership and possible actions to address or mitigate the risks.

A preliminary LCC risk/variability identification process should be carried out on every

project at this step, unless the scope of the project is such that risk is manifestly very low.

The depth and rigour of the process should be appropriate for the scope and nature of the

project. The results should be recorded on the first draft of a risk register (see section 5.6.1

following).

5.5 Assessing variability

Having identified potential causes of variability in the LCC assessment it is then necessary

to assess their potential likelihood and extent, for which a variety of risk assessment tools

and techniques is available. These fall into two broad categories:

Qualitative, employing subjective scoring techniques

Quantitative, using mathematical approaches.

Quantitative techniques fall into two further categories:

Statistical and probabilistic (stochastic) approaches

Deterministic, with numerical computation of risk.

The range of approaches is illustrated in figure 4 below, with those most widely applied toLCC highlighted.


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The choice of an appropriate methodology depends not only on the scope and rigour of the

analysis required but also on the quality and extent of data available. Relevant historical

data might be available in databases, or from organisations involved in the project.

However, there is little reliable historical LCC data held at a national or international level,

accordingly the availability and quality of relevant data should be reviewed beforeundertaking a risk assessment exercise.

When undertaking the risk assessment it is important to distinguish between planned costs

(which assume everything goes well) and expected costs (which include an allowance based

on experience for problems such as cost and time over-runs).

Figure 4: Common tools and techniques in risk/uncertainty analysis

Techniques for risk and

uncertainty assessments

Deterministic (numerical

computation of risk)

Qualitative (using subjective

scoring techniques)

Quantitative (statistical &probabilistic approaches)

Benefit and cost estimating

Break-even analysis

Risk-adjusted discount rate

Certainty equivalent technique

Sensitivity analysisVariance & standard deviation

Net present value

Other

Mean-variance criterion

Decision tree analysis

Monte Carlo simulation

Artificial Intelligence

Fuzzy set theory

Event trees

Confidence modelling

Other

Risk matrices

Risk registers

Event trees

SWOT analysis

Brainstorming

Likelihood/consequence assessment

Other

5.6 Qualitative risk assessment

Qualitative risk assessment is essentially a subjective process relying on the knowledge,

skills and experience of the participants, but undertaken in a managed manner. Methods of

drawing out this information are broadly similar to those used for risk identification, that is,brainstorming, reference to databases, interviews, etc. For each of the identified risks the

team will typically consider:

Their likelihood

Who / what is likely to be affected and to what extent

Who owns them

How important it is to mitigate them

What action should be taken.

A number of tools are available for qualitative risk assessment, of which risk registers are

the most user-friendly and commonly used. Compiling a risk register is normally the first

step in risk management and provides a format for systematically recording the outcomes ofrisk identification and assessment. The register should be regularly updated to contribute to


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risk management throughout the project life cycle. The information available in risk

registers can be used to initiate quantitative risk analysis and to support subsequent risk

mitigation.

The typical headings used in compiling a risk register include:

title and description of risk

description of causes

dates when the risk was identified / modified

risk code

ownership of the risk

likelihood of occurrence

potential impact

ranking

mitigation action plan and timescale

residual risk effects.

The level of detail on the risk register is a matter for judgement with reference to the scopeand complexity of the project.

Other qualitative tools which may be applicable include probability matrices and impact

assessment matrices, which can be used by the team to facilitate the related assessments for

entry onto the risk register.

A probability matrix facilitates the essentially subjective process of assessing the likelihood

of a risk event occurring by clarifying the concept of ‘probability’. A typical matrix is

illustrated in figure 5 below. The process depends fundamentally on the project team and

key stakeholders contributing to the process – knowledge of the project and related

activities within it, experience and historical data will all be relevant.

Figure 5: Probability matrix

An impact assessment matrix similarly facilitates the process of assessing the impact of

each risk, requiring a comparable contribution of knowledge and experience.


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5.7 Quantitative risk assessment

Quantitative risk analysis involves formulation of a model for computing the risk impacts

on quantifiable project performance measures such as cost and duration. In theory

quantitative assessment provides much better insights into risk and risk management, but it

can be difficult to apply in a construction context and expert advice is an essential

prerequisite, both for setting up models and selecting relevant data and interpreting the

results.

In practice, two techniques are likely to be of particular value in the LCC context and are

identified as such in ISO 15686 Part 5, namely sensitivity analysis and Monte Carlo

simulation.

5.7.1 Sensitivity analysis

Sensitivity analysis measures the impact on project outcomes of changing key input values

about which there is uncertainty, typically:

discount rate

future inflation assumptions

period of analysis

service life or maintenance, repair or replacement cycles

operational cost data.

For

life cycle cost analysis - info 1

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