Life Cycle Cost Analysis

• By Jeff Cryder, Maureen Lally
• 11/01/08

Public and private school districts spend $6B each year on energy to power their facilities, according to The Consortium for Energy Efficiency figures. Heating, ventilation, and air conditioning (HVAC) systems comprise approximately 45 percent of that energy use. That’s nearly $3B in energy costs every year — not to mention the associated maintenance costs.

Planning and implementing an HVAC project in the same manner as managing a large maintenance expense ignores two key issues:.

• HVAC upgrades, which will likely remain in place for 20 to 25 years or more, are capital investments made within a school district’s fixed asset management program.
• A facility that is comfortable in terms of temperature, humidity, air quality, noise level, and energy-consumption plays a “mission critical” role in a teacher’s ability to educate students, not to mention the students’ ability to learn.

For these reasons, school district administrators should undertake a more strategic, asset-management focus to new HVAC investments, and use a similar focus when examining other capital investment decisions.

Changing the Paradigm
Traditionally, bids for HVAC upgrades are solicited on a “first cost” basis. In these cases, the Requests for Proposals (RFPs) ask vendors to present their lowest possible pricing for the initial acquisition of their recommended equipment. Using a “first cost” basis to determine the bid outcome on the purchase of supplies or commodities is fine and acceptable.

But a major HVAC project is a capital asset: The installation will likely see some five decades of service, represents a substantial investment of funding, and the upfront cost of HVAC components often represent only five percent of the overall investment in terms of total cost of ownership over 20 or more years.

Despite this fact, many organizations continue to purchase HVAC upgrades on a first-cost basis. Only recently has the paradigm begun to change, with schools and other organizations maximizing efficiency and saving money by evaluating their HVAC projects in view of their life-cycle cost.

The Life-Cycle Cost (LCC) of an asset is “the total discounted dollar cost of owning, operating, maintaining, and disposing of a building or a building system” over a period of time, according to The National Institute of Standards and Technology (NIST) Handbook. An LCC analysis (LCCA) examines a capital project’s total costs of ownership by comparing initial, maintenance, repair, and operating costs over the life of the system.

In this era of ever-tightening budgets, a low-priced system is bound to appear extremely attractive. However, that low-priced system might have excessive lifetime operational costs, or it might have a short usable life, causing the buyer to replace it long before a new system should be necessary.

In order to make the most effective, efficient choice for your facility, all of these factors should be considered. That’s the benefit of the LCCA. A well-executed LCCA will result in one of three outcomes:

• acquiring equipment and systems that are outstandingly durable and therefore pay off their higher initial costs with lower operational and maintenance expenses;
• equipment and systems with lower initial costs and satisfactory, if not optimal, performance; and
• equipment and systems that raise the cost of construction and operations, but increase the facility’s performance (and profitability, in the case of private schools) to such a degree that it justifies the extra cost.

An LCCA differs from a number of other methods that have been employed in the past, simply because it takes into consideration this wide variety of factors. For example, the “payback method” only takes into consideration how quickly the initial investment can be recovered, without any measure of long-term performance or consideration of the system’s lifetime. An LCC analysis, however, accounts for the system’s lifetime, as well as a number of mercurial factors, such as the behavior of the equipment’s materials, the use of the facility, environmental conditions, and energy costs can affect a system’s overall costs.

As a complex analysis the LCC evaluation method requires an in-depth understanding of the process in order to ensure the best results. But the rewards are well worth the time and effort.

How to Get Started
Timing can be important in reaping the greatest cost benefits from an LCCA. HVAC system decisions can be affected by issues like building design and siting, so it’s important to get an LCCA as early as possible in the design process. Of course, for renovation or replacement of an HVAC system, the timing will be slightly altered to fit the project’s specifications.

An RFP is the first step. Rather than base the bid process on a “first cost” RFP, a more strategic and long-term asset management-based alternative is an RFP requiring each bid to include an LCCA.

Bid processes incorporating an LCCA help administrators determine the best value for its dollars among the alternatives. The goal is to create a system that can operate at peak efficiency throughout its lifetime, eliminate system shutdowns, and make use, when necessary, of non-corrosive materials in harsh environments.

The Cost Variable — Initial Expenses
There are three variables to consider when breaking down the LCC equation: the costs of ownership, the period of time over which the costs are incurred, and the discount rate that is applied to future costs to equate them with present-day costs.

To start, the costs of ownership variable can be broken down into two categories — initial costs and future costs. Initial costs are those incurred prior to installation of the HVAC system. Future costs are those incurred after the system is in place.

The capital costs for the HVAC system and controls are included in the initial costs category. Because controls are the most important factor in maintaining a high-performance HVAC system at your school, you’ll want them to be flexible. Factors to consider when selecting controls include centralized command and control; precise temperature and humidity control; ease of changing settings; control of critical core functions such as classrooms, administrative offices, and security; and ease and efficiency of testing and balancing equipment.

Construction expenses also fall into the initial costs bucket. Detailed estimates of construction costs are not necessary for preliminary analyses of building systems. These estimates are usually not available until the design process is rather far along and the opportunity for cost-reducing design changes has been missed. LCCA can be repeated throughout the design process if more detailed cost information becomes available. Initially, construction costs are estimated by reference to historical data from similar facilities, and several government and private sector cost estimating guides and databases also are available.

The Cost Variable — Future Expenses
All other expenses that will occur after the new HVAC system is in place fall into the future costs category — this includes energy, water and other utility costs, non-fuel operating costs, and maintenance and repair (OMR) costs.

Many future costs, like energy prices, are difficult to predict, so determining the exact value of expenses in each cost category can be a difficult task. A variety of energy modeling software programs exist that can help analyze the building’s projected use, occupancy rates, schedules, etc., to predict energy consumption. Energy prices, of course, are constantly in flux. But, a good LCC analysis will factor in an energy price projection as well as the rate type, the rate structure, summer and winter differentials, block rates, and demand charges to obtain an estimate as close as possible to the actual energy cost, according to the NIST’s guide on LCC analysis.

Utilities, such as water use, can be treated similarly to energy. For example, in terms of water use, the analysis must take into account usage and disposal.

The future costs included in the LCCA should account for maintenance costs, frequency, and preventive maintenance including non-labor intensive system tracking and monitoring, option for cost effective outsourcing, service calls, and parts and a provider availability of skilled technicians.

OMR costs often are more difficult to estimate than other building expenditures because operating schedules and standards of maintenance vary widely from building to building. Even between buildings of the same type and age there is great variation in these costs. Therefore, it’s especially important that the preparer use engineering judgment, based on your particular building and use projections when estimating these costs.

The number and timing of capital replacements of building systems depend on the estimated life of the system and the length of the study period. HVAC systems remain in place for several decades in most cases, so it’s important to take into consideration the costs of upgrades and modernization. If a low-cost system comes with exorbitant upgrade costs, it might be beneficial to take a look at alternative options that may have higher initial costs, but are more cost effective to upgrade over the system’s lifetime.

Your preparer will decide which costs are relevant to your project in order to produce a realistic LCC comparison of project alternatives — for example, will there be renovation costs associated with a system upgrade, or will the new system simply reside where there is an existing unit?

The Cost Variable — Non-Monetary Costs and Benefits
There isn’t an objective way to quantify some of the costs and benefits that result from an LCAA. One non-monetary effect of upgrading your HVAC system could be the benefit derived from a particularly quiet HVAC system. Also, because students require the highest possible standards for environment to perform at their peak academically, indoor air quality (IAQ), filtration, pressurization, airflow, and acoustics should also be considerations. You can choose an HVAC system that will provide the most optimal conditions.

Though non-monetary effects are external to the LCCA, they should still play a major role in the final investment decision.

The Time Variable
Time is the second component of the LCC equation. The study period for an LCC is the length of time over which the preparer will evaluate ownership and operations expenses. Typically the study period will range from 20 to 40 years, dependant on preferences and the intended overall life of the facility — however, it’s important to note that the study period is generally shorter than the intended life of the facility.

Similar to the way costs are broken down, the NIST divides the study period into two phases —  the planning/construction period and the service period. The first phase is the time from the start of the study to the date the new HVAC system becomes operational (the service date). The second phase begins on the service date and lasts until the end of the study.

The Discount Rate Variable
The third and final piece of the LCC equation is the discount rate. This is the rate applied to future costs to equate them to present day costs. The discount rate can be viewed as the number that would make you indifferent as to whether you receive a payment now or a greater payment at some point in the future. As the economies change, so does the discount rate. However, your preparer can refer to organizations like the U.S. Department of Energy, which has set a discount rate that is updated annually. 

An LCCA can be performed in constant dollars or current dollars. Constant-dollar analyses exclude the rate of general inflation, and current-dollar analyses include the rate of general inflation in all dollar amounts, discount rates, and price escalation rates. Both types of calculation result in identical present-value life-cycle costs.

An LCC analysis is a valuable assessment to help build and maintain facilities as assets, not commodities. A number of other considerations can further extend facility investments:

• financing programs that can help manage total cost of renovation by guaranteeing energy savings that will finance your HVAC systems improvements;
• energy modeling software helps you more accurately model building performance and compare reduced energy usage of your systems so that you can benefit from Energy Policy Act tax deductions as approved by the US Internal Revenue Service; and
• systems that provide optimum efficiency with a smaller footprint, building owners reduce the use of resources, water and energy, saving on costs, positively impacting the environment while increasing the amount of rentable or saleable volume within the building.

To gain access to these tools, as well as the widest range of cutting-edge equipment and systems, partnering with an innovative, knowledgeable HVAC provider is the first step to building optimal school, and by extension student, performance and efficiency.

Jeff Cryder is the Controls Contracting Leader for Trane and is based in St. Paul, MN.

Maureen Lally is institutional markets director for Trane where she works to understand the needs of Trane's education and healthcare customers and provide solutions to those customers.