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Determination of life cycle costs

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Financial Analysis

You are a financial analyst for the fictional Evergreen School District in Washington. The Facilities Department has proposed replacement of the heating and ventilation systems in the District's twenty elementary schools. The current systems have reached the end of their useful lives and maintenance costs are increasing dramatically. The Department recommends buying traditional systems made by Mega Manufacturing (MM). These systems each cost $425,000 and each will cost about $60,000 to install. Annual maintenance costs are $5,000 per system. A major overhaul is needed every five years at a cost of $20,000 perdetermine the life cycle costs of the MM and GTG systems system. The systems use natural gas and expected fuel costs are $30,000 per system per year.

Two members of the School Board have signed onto the "Green Evergreen" campaign. They want the District to invest in systems and programs that don't contribute to global warming. They have asked you to consider an alternative system made by Greener Than Green, Inc. (GTG). The GTG systems rely on a combination of solar and wind power and thus have no fuel costs. However, the systems are much more expensive to purchase. Each system will cost $775,000 and will cost about $80,000 to install. Annual maintenance costs about $10,000 per system per year. GTG says that no major overhauls will be needed.

Both the MM and GTG systems have an expected useful life of 15 years.

The Budget Director has told you that the District does not have funds available in the current budget to pay for these systems. Thus, debt will be issued to pay the initial capital costs. These bonds will be issued at the same time as the systems are purchased and installed. The bonds will have a 10- year term and will have level debt service at a projected 4.5% interest rate.

Your task is to determine the life cycle costs of the MM and GTG systems. The life cycle cost includes the debt service on the bonds. The District uses a 5% discount rate.

Your analysis should be summarized in a one-page memo with attached tables. Your memo should identify which system has the lowest life cycle cost and the best Net Present Value. The memo should list any other issues or concerns that you believe should be considered in making the decision about which system to purchase.


Solution Preview

Life cycle costing is a part of cost accounting. Cost accounting is providing information, which is helpful in monitoring and evaluating management performance

It will help in assessing the costs at every stage of the operation.
This will include the analysis of:

* planning,
* Research and development,
* Production,
* Operation,
* Maintenance,
* Cost of replacement,
* Disposal or salvage.

This cost analysis depends on values calculated from other reliability analyses like failure rate, cost of spares, repair times, and component costs.
(Wikipedia) as retrieved on 15 Oct 2007 15:54:39 GMT.

Solution Summary

This explains the determination of life cycle costs