Stochastic Life Cycle Costing

Life Cycle Costing (LCC) analysis helps you compare several investment opportunities based on the costs and revenues each investment generates over several years. You learned how to perform a simple LCC in the first Application Note.

Basic LCC is a good method for making informed decisions, but the outcome of such an analysis depends heavily on the quality of the input data and the assumptions you make. Energy prices, maintenance expenses, availability and discount rates are just some of the parameters you need to estimate. But it doesn’t stop there. You also need to able to defend your estimates. After all, each parameter can have a huge impact on your final decision. A critical audience, such as your management or funders, will undoubtedly test the robustness of your decision.

You can strengthen your case by including a sensitivity and risk analysis – in other words, perform a stochastic LCC analysis. It doesn’t necessarily require more or better information than a basic LCC analysis, but it does allow you to deal more effectively with the limited information at your disposal. A sensitivity analysis shows you how robust your decision is: in other words, would your choice between several investment opportunities change if any of the input parameters changed? A risk analysis shows you which risks you could manage to safeguard the profitability of your project.

This Application Note will teach you the basics of Monte Carlo Simulation, a powerful method that allows you to deal with risks and uncertainty by building and running a stochastic LCC model. Each step in the 5-step procedure is illustrated with a running example, which you can check yourself in MS Excel, using a free software add-in.