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Sensitivity Analysis of Life Cycle Cost

Calculation
Andrea Lang
July 2, 2007

Abstract
This paper presents a sensitivity analysis of the life cycle cost calcula-
tion made in the master thesis “Maintenance management of wind power
systems - Cost effect analysis of condition monitoring systems” by Julia
Nilsson (2006). In that thesis, the possible economical gain of a condi-
tioned monitoring system (CMS) in wind power plants is investigated, by
comparison of life cycle costs for different scenarios. In the life cycle cost
calculations, the discount rate was set to 7%. This sensitivity analysis
aims to look at how the results of the study in the thesis depend on the
choise of discount rate.

1 Introduction
In many buisness projects, cost effectiveness analysis are of great interest. For
this purpose, the method of life cycle cost analysis is often used, which calculates
the total cost of the project or product over its life time, and at the same time
makes partial costs and their mutual dependance visible. This kind of analysis
is often used for comparison of differnt project alternatives, and for optimization
of cost effectiveness.
In the master theis “Maintenance management of wind power systems” by
Julia Nilsson [2], a life cycle cost analysis of wind power projects was performed,
with the aim of evaluating the possible economical gain associated with the
installation of a so called condition monitoring system (CMS). The economical
gain is due to the fact that a CMS allows for more efficient maintenance planning
[1] which means lower maintenance costs. Maintenance of wind power plants is
furter explained in Section 3.
The approach in [2] was to compare life cycle cost calculations for different
scenarios (with and without CMS), in order to see how different maintenance
costs are affected.

2 Theory of Life Cycle Cost Analysis


The life cycle cost (LCC) of a project or product is defined as the cumulative
cost of the product over its entire life span [3]. The total cost can be devided
in different ways, depending on the application, but it typically includes costs
for planning and reaserch, investment, operation, maintenance and disposing of

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the product. A life cycle cost analysis is the technique for calculating the total
life cycle cost of a product.
The purpose of a life cycle cost analysis is not only to determine the total
cost of a project, but also to compare costs of different alternative project plans
and to see what alternative would be the most cost efficient. One of the main
benifits of the analysis is that it makes different partial costs of a project visible,
and also shows how different costs are related to each other. For example, a
high investment cost could mean low operating and/or maintenence costs in the
future.

2.1 Present Value Method


When calcutating the total cost over a time span, it is necessary to combine
outlays spread in time in an accurate way. The principal method for this is
called the present value method, which compares the value of a cash unit today
to the value of that same cash unit in the future, taking inflation and return
rates into account. The idea of the method is to determine the present value of
a future cost (or income) by discounting.
Suppose, for example, that we know that we have an outlay of e1000 in five
years, and that we can invest money somewhere at a return rate of 6% per year.
How much do we have to invest today, in order to have the e1000 for our outlay
in five years? This amount is obviously smaller than e1000, and it is called the
present value of the outlay.
If a cash amount V is invested today at the return rate of d% per year, then
after n years this amount has grown to C = V (1 + d)n . Inversely, this means
that an outlay C in n years, corresponds to an investment V = C(1 + d)−n
today. This value V is the present value of the outlay C. This leads to the
following definition: The present value V of an amount C of cash that is to be
payed or recieved in n years, is

V = C(1 + d)−n ,

where d is called the annual discount rate.


According to the present value method, the life cycle cost of a product is
the total discounted cost of owning, operating, maintaining, and so on, over
the products life span. By “total discounted cost” is intended the sum of the
present values of all costs. This sum is called the total present value (TPV),
and is the total life cycle cost according to the present value method.

2.2 Discount Rate


One improtant task when performing an LCC study, is to chose an appropriate
discount rate. Usually, a recently started up company uses a significantly higher
discount rate than an established company, due to the fact that new companies
are associated with higher risks for investors.
One famous method for choosing a discount rate is the Capital Asset Pricing
Model (CAPM). This method looks at three variables when determining the
discount rate:
1. The risk free rate (for example the return rate associated with government
bonds).

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2. The so called beta value, wich is a measurement of how a company’s stock
price varies with changes in the market.

3. Investors requirements on return rates above the risk free rate. These are
different for different companies.
This model will not be further investigated here, but is mentioned only to show
that the choise of discount rate is not obvious or trivial. That is why we are
interested in knowing what happends with the results in [2] when the discount
rate is changed.

2.3 Present Value Method: Summary


ˆ The present value of an outlay that is to be payed in the future, is the
corresponding amount of money that has to be invested at the reference
year zero.
ˆ The present value V of an amount C of cash that is to be payed or recieved
in n years, is
V = C(1 + d)−n ,
where d is the annual discount rate.
ˆ What discount rate to use depends on the company performing the LCC
study. The aim of this work is to see how the choise of discount rate affects
the results of the LCC analysis.

3 Maintenance
The life cycle cost analysis in [2] is focused on costs for maintenance, since those
are the costs that could be reduced when installing a CMS. By maintenance
is here mainly intended reparation or replacement of components in the wind
power plant. The maintenance is divided into different types:

Preventive maintenance: Aims to anticipate failures. In [2], the preventive


maintenance is split into two kinds:
ˆ Scheduled maintenance: Performed at predetermined times, accord-
ing to a schedule; disregarding the contition of the components.
ˆ Conditioned based maintenance: Carried out according to creteria
based on the condition of the system components.
Corrective maintenance: Repairs or replacements after the occurance of a
failure.

In maintenance planning, the aim is to optimize the balance between preventive


and corrective maintenance. The idea of a CMS is to gain more information
about the condition of the different components, in order to render possible a
more sophisticated conditioned based maintenance. However, in the calculations
in [2] (and hence also here), there is no conditioned based maintenance, only
scheduled, since the collected data do not contain information about costs for
conditioned based maintenance, see Section 6.

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4 LCC for Wind Power Systems
In this application (see [2]), the total life cycle cost has been divided into the
following partial costs: investment, Cinv , preventive maintenance, CP M , cor-
rective maintenance, CCM , production loss, CP L and remainder value/disposal
cost, Crem :

Ctotal = Cinv + CP M + CCM + CP L + Crem (1)

The idea of the LCC study in [2], is as follows: First, the total present value
of these costs is calculated. Then the CMS is introduced, imposing an extra
investment cost of e20.000. The qustion now to be answered is: By how many
percent must the different costs decrease in order to pay for the investment cost
of the CMS? In [2] this was done in Excel using a fixed discound rate of 7%.
In this work, a small matlab function was developed, that calcutates the same
thing for an arbitaray discount rate, see results in Section 7. The model is:

T P V (Cinv + CP M + CCM + CP L + Crem ) =

P V (Cinv + a1 CP M + a2 CCM + a3 CP L + Crem ) + CCM S (2)


The following four strategies were used here:

1. If only the preventive maintenance is changed, with how many percent


must it decrease in order to pay for CMS? (In (2): what is the value of
a1 , if a2 and a3 are kept equal to one?)
2. If only the corrective maintenance is changed, with how many percent
must it decrease in order to pay for CMS? (In (2): what is the value of
a2 , if a1 and a3 are kept equal to one?)
3. If only the production loss is changed, with how many percent must it
decrease in order to pay for CMS? (In (2): what is the value of a3 , if a1
and a2 are kept equal to one?)
4. If the preventive and the corrective maintenance are changed equaly, with
how many percent must they decrease in order to pay for CMS? (In (2):
a2 and a3 are set to the same value while a1 is kept equal to one.)

These are not exactly the same strategies as in [2], except for the first and the
fourth one, but since the scope of this work mainly was to investigate the staba-
bility of the results when changing the discount rate, the exact correspondance
of the stratigies are not of main importance.

5 Sensitivity Analysis
In the life cycle cost calculations in [2], the discount rate was set to 7%. The
scope of this sensitivity analysis was to look at how the calculations in Section
4, which correspond to the ones in [2], depend on the choise of discount rate.

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Figure 1: Required decrease of maintenance costs as a function of the discount
rate, for the single onshore turbine at Gotland

Figure 2: Required decrease of maintenance costs as a function of the discount


rate, for the offsjore wind park at Kentish Flats

6 Data
The data used for the calculations of which the results are presented in the
following section, are the same as in [2], and come from two different studies:
one is a single wind turbine onshore at Näsudden on Gotland, and one is the
offshore wind farm at Kentish Flats outside London, consisting of 30 wind mills.
All the studied wind turbines are 3 MW and of type Vestas V90.
The data for the single onshore turbine are based on an interview with An-
ders Andresson, operation manager at Vattenfall, Gotland. Data for the offshore
park are based on an interview with Torben K Hansen, project team manager at
Kentish Flats. Note that these data do not contain costs for conditioned based
maintenance, so here preventive maintenance means scheduled maintenance.

7 Results and conclusions


The four strategies were performed for discount rates of 1%, 3%, 5%, 7%, 9%
and 12%. The results are presented in Figures 1 and 2. From these results, it is
obvious that the choise of discout rate, as expected, affects the cost calculation,
but there does not seem to be any instability. The main difference between
the two cases, is that preventive maintenance is a much lower cost for the
single onshore turbine. That is why it needs to decrease so strongly in order to
compensate for the CMS. So for the single turbine, it would be more interesting
to lower the costs for corrective maintenance.

8 Discussion and Future work


Some important notes:

ˆ In the data file used in [2], all costs are given in todays currency, which
means that the discount rate should be low, in order to compensate for
infaltion. Considering this, a rate of 7% could seem quite high.
ˆ The idea of a CMS, is to make possible the use of condition based main-
tenance. The calculations here and in [2], however, only considers sched-
uled maintenance since no cost data for condition based maintenance were
available.

Questions for future work:

ˆ What is a reasonable discount rate for this kind of calculation? Is it very


different for different companies (recently started, established)? How do
companies chose the discount rate when they do LCC calculations? So

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here are two questions: how “should” the discount rate be chosen, and
how is it chosen by companies?

ˆ What kinds of CMS are available at the market, how much do they cost,
and with what service contracts are they associated?

References
[1] Lina Bertling, Thomas Ackermann, Julia Nilsson, and Johan Ribrant.
Förstudie om tillförlitlighetsbaserat underhåll för vindkraftsystem. Elforsk
rapport 06:39, 2006.
[2] Julia Nilsson. Maintenance management of wind power systems - Cost ef-
fect analysis of condition monitoring systems. Master of science thesis, De-
partment of Electrical Engineering, Royal Institute of Technology (KTH),
Stockholm, Sweden, 2006.
[3] IEC International Standard. Application guide - Life cycle costing. Reference
number 60300-3-3:2004.

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