Life Cycle Cost

Posted in Finance, Accounting and Economics Terms, Total Reads: 352
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Definition: Life Cycle Cost

It refers to the cost of product that includes all possible costs that may be incurred during the life cycle of the product, right from acquisition to disposal of the product. It’s obtained through the method of economic analysis i.e. called as ‘Life Cycle Cost Analysis’ (LCCA). Managers use LCC in order to select among various alternatives and make important decision. The various costs involved in the life cycle of product can be shown as follows:



Initial acquisition costs are just a portion of total cost that may incur during life cycle of a product. Hence, it’s very important to consider all costs before making any decision on going ahead for acquiring a product.


Example, suppose there are two machines: fully automatic and semi automatic. The cost of acquisition for fully automatic cost is higher than semi automatic one, but the cost of using fully automatic is much lower than the other. Also, total cost (i.e. life cycle cost) of fully automatic machine is lower than the other. In this example, making decision over cost of acquisition won’t be correct.


The steps for computation of LCC can be written as follows:

1. Identify all the cost elements involved during life cycle of product

2. Assign timeline to each cost element

3. Estimate value of each cost element

4. Calculate present value(PV) for each cost element

5. Calculate Life Cycle Cost by adding all present values

LCC can be represented as following formula:

 

Life Cycle Cost =PV (initial acquisition cost + operating costs + maintenance costs + disposal costs - residual value)


Once LCC for all the alternatives are calculated, it gives clear picture to manager which option to consider or discard. The advantages of LCC are ranking or prioritizing various alternatives, reduction of risk involved and better reporting to the stakeholders.

 

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