# LCCA for HVAC systems

## Lifecycle cost analysis (LCCA) is a tool used to determine the most cost-effective option among HVAC system alternatives.

**Learning objectives**

- Understand basic lifecycle cost analysis (LCCA) concepts and best practices.
- Learn to incorporate LCCA into an HVAC system selection process.
- Identify tools that simplify LCCA calculation and results documentation.

Practically speaking, there are multiple building design options that can meet programmatic needs and achieve acceptable levels of performance. From a purely financial perspective, the only appropriate design alternative is the solution that satisfies the owner's project requirements for the lowest total cost of ownership. Lifecycle cost analysis (LCCA) is a powerful tool used to determine the most cost-effective option among competing alternatives. Although LCCA has been used for decades to reliably identify cost-optimal design solutions, many building owners and architecture and engineering professionals still rely on simple payback to make project investment decisions.

LCCA is an economic method of project evaluation in which all costs arising from owning, operating,maintaining, and ultimately disposing of a project are considered to be potentially important to that decision. LCCA is particularly suitable for the evaluation of building design alternatives that satisfy a required level of building performance (including occupant comfort, safety, adherence to building codes and engineering standards, and system reliability), but may have different operating, maintenance, and repair (OM&R) costs, and potentially different useful lives.

Project-related costs that occur at different points in time cannot be directly combined for meaningful economic analysis because the dollars spent at different times have different values to the investor. LCCA provides a rational means to weigh the value of first costs versus future (e.g., operating) costs (see Equation 1).

**Adjusting to present value**

Most individuals intuitively recognize that a dollar today does not have the same value as a dollar in the distant future. This concept, referred to as the time value of money, results from two considerations: 1) general inflation, which is the erosion of future purchasing power; and 2) opportunity cost, which for existing capital is the cost of forgone investment opportunities and for borrowed capital is the cost of borrowing (i.e., the loan rate). Lifecycle costing considers both effects in weighing the value of present costs against future costs.

**General inflation and price escalation:** General price inflation measures the decline in the purchasing power of the dollar over time. LCCA methodology provides two approaches for dealing with general price inflation: current dollar analysis and constant dollar analysis. Current dollars are dollars of any 1 year's purchasing power, inclusive of inflation. That is, they reflect changes in the purchasing power of the dollar from year to year. In contrast, constant dollars are dollars of uniform purchasing power, exclusive of inflation. Constant dollars indicate what the same good or service would cost at different times if there were no change in the general price level (no general inflation or deflation) to change the purchasing power of the dollar.

In general, LCCA calculations for building systems should treat general price inflation using a constant dollar approach. The constant dollar approach has the advantage of avoiding the need to project future rates of inflation or deflation, which adds unnecessary complexity and uncertainty. The price of a good or service stated in constant dollars is not affected by the rate of general inflation. For example, if the price of a piece of equipment is $1,000 today and $1,050 at the end of a year in which prices in general have risen at an annual rate of 5%, the price stated in constant dollars is still $1,000; no inflation adjustment is necessary. In contrast, if cash flows are stated in current dollars, future amounts include an assumed general inflation rate and an adjustment is necessary to convert the current-dollar estimate to its constant-dollar equivalent.

Few commodities have prices that change at exactly the rate of general inflation year after year, but many commodities have prices that change at a rate close to that of general inflation over time. Maintenance and repair costs and construction materials tend to follow general price inflation, while utility prices tend to be much more volatile. Typically, LCC methodology assumes that prices for all goods and services, other than for energy and water, will increase at approximately the same rate as general inflation. However, if there is a documentable basis for assuming that prices change at a rate different than general inflation(e.g., when price escalation rates are established in a maintenance contract), these rates can be used in the analysis.

While goods and services are assumed to inflate at the same rate (i.e., the general inflation rate), LCC procedures require that inflation of energy prices be treated separately. In other words, this assumes that energy prices will not inflate at the same rate as other goods and services. Accordingly, we distinguish general price inflation from energy price inflation by referring to the latter as energy price "escalation." As with the use of the discount rate, the energy price escalation rates are "real" (i.e., net or differential).

The U.S. Energy Information Administration (EIA) publishes official projections for future energy prices annually each April for the residential, commercial, and industrial sectors broken down by region of the country for six energy types (electricity, natural gas, propane, distillate fuel oil, residual fuel oil, and coal).Figure 1 illustrates how the Dept. of Energy projects national average electricity, fuel oil, and natural gas prices are expected to move over the next 30 years in real dollar terms. These fuel escalation rates are suitable for most building-related LCCA studies. If using alternative escalation rates, be sure to use "real"rates that indicate how energy prices will increase above and beyond general price inflation (Note that

Equation 4 may also be used to convert a "nominal" escalation rate into a "real" escalation rate).

Given a present price and a real escalation rate Equation 2 may be used to determine an escalated future price. For example, assume the present price of natural gas is $1.00 per therm and that the price of natural gas is anticipated to escalate at a constant rate of 5%. At the end of year-10 natural gas will cost$1.63 per therm. In all likelihood, general price inflation will drive the actual price of natural gas higher than $1.63 per therm in year-10. However, constant dollar analysis focuses on incremental price change for energy by using "real" escalation rates. Note that this escalated price ($1.63) may not be used in Equation 1 until it is discounted to present value using Equation 3.