Life Cycle Cost in Construction Projects and Time Value of Money

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What is Life Cycle Cost in Construction Projects?

Life cycle cost in construction projects is a process of economic decision analysis, which helps taking decisions on investments in new construction. These decisions on investments are analyzed for the payback over the life of the investment. This method is also known as life cycle costing technique in construction industry. The life cycle costing technique helps to reduce the overall cost of a project by selecting best alternative designs and components to minimize the cost not only at the time of construction, but also the over the full life of the project. The life cycle costing simply does not considers the least cost of construction, but it considers a mechanism to determine which alternatives offer the largest economic advantage by considering costs and benefit that occur throughout the life of the project from initial concept of project to its construction and its useful life to the time it is ready for replacement. It helps the project designers to select the best alternative for the given project.

The aim for life cycle costing is to present owner of the project with maximum benefit when all the costs are accounted for by analyzing the alternative designs and components. In this process, the costs are analyzed with the benefit in the future. For example, how the cost of extra expenditure on a particular component can benefit in the project owner now or the investment shall be carried out only in future for that component. What will be the best alternative for that component now or in the future? Life cycle costing provides framework for making analysis of costs and benefits based on time value of money. This helps the analysts to compare and select from alternatives that have different spans and diverse cost and benefit profiles.

What is Time Value of Money in Construction Projects?

Time value of money is defined as the purchasing power of money now to the purchasing power of the same money in future. It is a method of assessment of market for the value of money with time. For example, you can purchase a component at a price $5000 now, but will you be able to purchase same component at the same price 5 years later? What if you would like to purchase it now, then will you be able to gain advantage over the purchase after 5 years from now? Or to gain advantage, you would like to invest it somewhere else and purchase same after 5 years. It is a method of assessment of cash flow from present time to future with the analysis of profit or loss, or the benefits one would get with the amount.

There are different methods for assessment of time value of money, they are:

1. Compound interest method
2. Nominal and effective interest rate methods
3. Equal life alternatives
4. Unequal life alternatives
5. Incremental cost analysis

Read More: Phases in Life Cycle of a Construction Project -Planning, Execution