When making investments in tangible goods, it is always wise to consider the long term monetary cost of owning it. This is especially true when purchasing or leasing expensive items such as vehicles, buildings, and structures. By performing a life cycle cost calculation, you can easily determine the true cost to own the commodity. Similar to Life Cycle Assessments (LCAs) that evaluate the environmental impacts of products and services, this calculation will give you the true cost of ownership for a particular item. This concept can be applied to nearly every product that you can own. However, in this article I will focus on buildings.
The Basic formula for calculating life cycle cost is:
LCC = P + I + Re - RS+ D + E + W + M + O Where:
LCC = The total life cycle cost (present value) of the structure (dollars)
P = The initial cost of the structure (total purchase price not counting interest if it is a loan)
I = Interest paid on the loan amount used to purchase the building.
Re = Replacement cost of the building (present value)
RS = Resale or salvage value of the structure at the end of its useful life (present value)
D = Disposal costs to remove the structure at the end of its useful life (present value) Note that this could be zero if the building will be sold instead of demolished.
E = Estimated energy costs of the structure (useful life)
W = Estimated water costs of the structure (useful life)
M = Estimated maintenance, repair, and upkeep costs of the structure (useful life)
O = Estimated other costs associated with ownership of the structure (Administrative, Permitting, Licensing, etc)
There are several variations of this formula available on the Internet and in published literature. Every situation is different, however, the basic concept behind a life cycle cost assessment is the same. In some cases, you may need to include such things as costs for internet and phone services, gasoline usage, or even the cost of building upgrades.
Example LCC Calculation:
Your company has experienced explosive growth in the last two years. In anticipation of your next round of hiring, you are charged with finding and purchasing a new building to house 1,000 employees as well as computers, servers, and other office equipment. After some searching, you find two great looking buildings that fit your needs. Building A was built in 1950 and has a purchase price of 35 million dollars. Building B was built in 2010 and has a purchase price of 45 million dollars. The structure will be financed at an interest rate of 4.5% over a 20 year term. Given that location is not an issue and you intend to use the structure for at least 20 years, which building would you choose? The table below summarizes the LCC computations.
This calculation is highly sensitive to the input values and can be quite subjective if not done carefully. A true LCC estimate involves thorough research into the characteristics of the building. Additional calculations will be necessary to determine the inputs to the LCC computation.
Given this set of conditions, you should choose Building B. Even though Building A has a smaller purchase price (and therefore less interest on the loan), Building B is has a much lower operations cost associated with it. Over the useful life of the structure, you will end up expending less money if you purchase the initially more expensive building. In this case, this can be attributed to the fact that the new building is more energy efficient and will require less repairs. It is undoubtedly important to think about the true cost of ownership when make a large investments such as leasing office space, purchasing a home, or buying a car. This kind of thinking can even be applied to the decision making process.
Aurelio Locsin from Orange County, CA on June 15, 2011:
Thanks for explaining his complex calculation. Voting this Up and Useful.