II. ISSUE AND RECOMMENDATION SUMMARIES (CONT'D)

F. LIFE-CYCLE COSTING

CONST 23: IMPROVE DATA BASES AND ENFORCE
LIFE-CYCLE COSTING REQUIREMENTS

Issue and Savings

Can savings be realized in fixed-asset acquisition decision making through more effective use of life-cycle costing (LCC)? Evaluation of life-cycle costs can provide better selections among investment alternatives.

No specific cost savings have been identified at this time for this issue.

Background

LCC is a method for analyzing facility and building systems, equipment, and materials. It takes into consideration fixed costs, operating and maintenance costs, life expectancy, residual values, and the cost of money. It is a recognized and established technique for estimating the total costs to acquire, own, operate, and maintain buildings, systems, components, or equipment over a given period of time.

This technique is used primarily to compare alternative investments taking the cost of money into account. LCC discounts future transactions using an interest rate to capture the cost of money. All elements of a stream of expenses or receipts are thereby collapsed into a single number, known as the "present value" of that stream. In evaluating LCC comparisons, the alternative with the highest present value is considered preferable.

LCC is important in several phases of the construction decision-making process. It is applied routinely by private sector interests for fundamental planning and project justification decisions. LCC is applicable not only to alternative investments but also to the alternative means of financing investments (leasing vs. purchasing).

LCC in Federal construction is specified by law. In addition, regulations to be utilized in the decision phase of most types of projects also often specify the use of LCC.

Effective LCC analysis is a function of good basic data. The cost of construction, the expected future cost of maintenance and operation, and residual values are essential. LCC can be applied effectively only after a sufficient level of design has been completed to enable all alternatives to be compared on the same basis. In general, LCC calculations are performed only after 35 percent of the design is completed. The notable exception is in the General Services Administration (GSA).

The major area of uncertainty in the use of LCC revolves around specification of the interest rate.

Methodology

Telephone and personal interviews were conducted with a number of officials of the National Research Council, GSA, Veterans Administration (VA), Bureau of Standards, Corps of Engineers (Corps), and Navy Facilities Engineering Command (NAVFAC).

Numerous documents, directives, and handbooks were

examined.

The case studies conducted by the Construction Task Force were also reviewed to evaluate the impact of LCC, if any, on the projects examined.

Findings

The concept of LCC used by Federal Executive Branch agencies is comparable to that used in the private sector. The procedure is well defined, and the various directives and instructions are clear. All personnel interviewed by the Task Force exhibited good understanding of LCC, its uses, and its problems. Findings for specific agencies and programs are discussed below:

Department of Defense (DOD) -- Of all Government Agencies, DOD has had the most success in applying LCC analysis. It has used LCC for the last 20 years in procuring weapons systems and other hardware.

GSA GSA has been orienting its analyses of real property acquisitions toward a present-value/discountedcash-flow LCC methodology since 1972.

In July 1982, GSA's Public Buildings Service issued the Project Planning and Development Handbook, (PBS P700012). This handbook contained procedures for performing LCC analyses using GSA's automated model.

The procedure for performing LCC analysis is well documented and understood in theory at GSA. In actuality, GSA has not performed LCC analyses with any consistency or regularity and has not made LCC an absolute requirement.

The Task Force did not find any instances where LCC analyses had actually been applied at each of the prescribed stages of a building project, as GSA-documented procedures recommended. The problem has been attributed to a lack of cost data.

GSA has, however, experienced some success in applying a simplified method of LCC analysis to "supply procurements."

GSA data bases on various costs are not adequately maintained. Cost figures are basically extrapolations from prior years, some as early as 1960. The process results in inaccurate cost figures that do not reflect current experience. As a result, most GSA LCC analyses do not compare alternatives on the basis of accurate data.

Federal Highway Administration (FHWA) -- LCC is not applied to highways. The reason provided was that not

enough information is available to estimate maintenance costs for these types of construction projects. Until more experience is gained and the relationship between usage and wear and tear is more fully understood, better defined LCC cannot be applied.

Urban Mass Transportation Administration (UMTA) UMTA prescribes an absolute requirement that UTMA grantees perform LCC in the formulation of their projects. To date, UMTA has not received even one analysis in response to this require

ment.

Corps of Engineer Civil Works Program The Corps civil works water resource development program is exempt by law from LCC requirements. However, under different rules, discounting procedures are used to formulate and evaluate alternative investments. The net effect is essentially the same as LCC procedures. The Corps uses a discount rate prescribed by law which is pegged to long-term borrowing rates of the Federal Government. The rate is recomputed every year by the Treasury according to a legislatively established formula and is published by the Water Resources Council in the Federal Register.

While this discussion focuses on the Corps, the same situation exists for the Bureau of Reclamation and Soil Conservation Service, which also have major water resource programs falling under the same rules.

Conclusions

While LCC is prescribed for most major Federal construction programs in one form or another, the method is not employed consistently or accurately by all agencies. The effectivenesss of this useful tool is hampered by the failure to enforce LCC requirements and insufficient data and confusion about discount rates in some cases. There does not appear to be a unified approach to LCC which will yield consistent results throughout the Government.

In GSA, in particular, there is an apparent lack of recognition of the decision-making implications of inaccurate LCC analyses.

While the use of different discount rates for different LCC analyses is appropriate, the subtleties of these variations are not well understood within the Government. Generally, the correct discount rate is the required rate of return for an investment, given a certain level of risk. The discount rates used in water resource planning do not yield consistent or reliable results. The unstable planning environment created by variable rates and the grandfathering of projects create confusion and controversy. Recommendations

CONST 23: LCC analyses should continue to be used and their use expanded where possible. The Office of Management and Budget (OMB) should conduct a high-level review of the LCC methods used by individual agencies: the data bases used, the level of enforcement, and the discount rates used. The relevant laws prescribing discount rates used in water resource programs would be amended to adopt a single rate for such investments.

The review of methodology and data bases should take into account the trade-offs between timeliness of analysis, the costs of data development, and the level of accuracy required for specific types of decisions. Excessive analysis requirements should be avoided in any prescribed changes. A tiered approach to data development and LCC should be considered for screening decisions as opposed to final go/no-go decisions. All agencies should be required to review their conventional assumptions against actual experience and report the results to OMB.

Given GSA's role in the construction and acquisition of buildings, it should:

Require LCC analyses for all building projects;

Begin to build a data base for use in future LCC analyses in a format compatible with the Building Owners and Managers Association (BOMA) data; and

Make better use of expert judgment and cost estimates where data are not available.

Savings and Impact Analysis

Given that the issues surrounding the use of LCC in Government construction programs relate primarily to data and variable interest rates in some programs, it is impossible to estimate savings resulting from changes in LCC analyses procedures. If all the correct data were available, there would be no data problem. If consistent predictable discount rates were used in the water resources programs, there would be a basis for estimating the impact of changes. Implementation

O

Currency of data,

The dollar magnitudes associated with typical
projects where LCC is employed, and

Administrative and engineering resources used to perform LCC.

Legislation should be drafted by the appropriate Congressional committees amending Section 80 of the Water Resources Development Act of 1974 (P.L. 93-251).