The stormwater system that costs the least initially is not necessarily the most cost-effective system over time. A system with lesser construction costs may have a higher maintenance cost than another system under consideration, which has a lower initial cost. With new developments, the owner is not commonly the company that bears the initial cost of the system.
The homeowner or owner of commercial space becomes responsible for a treatment system that is initially paid for by the development company. In these situations, the developer’s motivation is to choose the system with least initial cost. There is little interest in considering life-cycle costs and no incentive to select the system with the lowest life-cycle cost. The system with the lowest initial cost is always chosen.
There are exceptions to the above disconnect between developer and owner. Many local, state, and federal jurisdictions install treatment systems at their maintenance yards, parks, streets and freeways, and other public property. Industries pay for both the initial and long-term maintenance costs of their treatment facilities. These agencies and companies have a very strong and direct reason to use life-cycle-cost analysis.
With sufficient information, regulators can conduct life-cycle cost analysis. From such analysis, a regulator might decide not to allow a system with a low initial cost but with relative high maintenance costs, which results in the higher life-cycle cost amongst the alternatives.
However, it is not clear at this time that particular systems will always have a highest life-cycle cost in all situations, even in a particular region or community. If this is the case, the alternative is for the regulator to require that a life-cycle-cost analysis be done for each development or public project, with the requirement that the least-cost solution amongst the alternatives under consideration is selected.
The view expressed above is that the least-cost system should be selected, or alternatively, those that are found to consistently have the highest life-cycle cost should be banned in a particular community or region. But this may not necessarily be the best policy. A local regulator may prefer that in residential developments, for example, a system with the lowest long-term maintenance costs be installed even though it has a higher initial cost than the alternatives because it may be the view of the regulator that such a system is more likely to be maintained by the homeowners association.
Life-cycle costs can be presented in either of two formats. One format is as the total value representing the total costs over the life of the facility. This is called present value. Alternatively, the cost may be presented as an equivalent annual yearly cost. This is called the annualized cost.
The Method
Presented here is a summary of the concept. The method involves adding the initial cost to the accumulated maintenance costs over the useful life of the system. A dollar spent 30 years from now is of lesser value in today’s dollars given inflation and the value of that money if it is invested in some other manner.
The above is the economist’s perspective. This consideration is called discounting, using a discount rate. The long-term stream of annual costs is discounted to present value. Each year of cost through the structural or practical life of the project is discounted and added to each of the other discounted years. This appears cumbersome. However, economists have provided a simple means of making the calculation, presented in this section.
Simply, the total life-cycle cost is the initial costs plus the discounted stream of benefits over the life of the facility. The initial costs are typically the construction costs plus a percentage to represent design and management costs: all costs associated with and attributable to the construction phase. An adjustment of 25% is perhaps valid but may be larger for smaller projects.
Two other costs to include in the analysis are taxes lost with surface facilities as well as the opportunity costs due to the loss of land over time, as for a home or parking area. If the facility is a surface facility like a wet pond, the cost of the land should be included, and/or the opportunity cost.
What should we select as the life of the facility? There is the structural life; this might be 50 years with periodic replacement of elements of the facility such as pumps, if used, or metal elements that deteriorate. But the useful life–the date by which the facility may no longer be used because of changing policies–might be less, perhaps 30 years in comparison.
Obviously, the choice of useful life is very uncertain, open to differing opinions. However, the effect of the decision is mitigated by the fact that the value of a dollar at 30 to 50 years is considerably less than today. Hence, whether one selects 30 or 50 years has a modest impact on present worth. Twenty years is most commonly used. In addition, the analysis is a comparison of several alternatives.
Thus the decision generally has little bearing on the outcome. However, the choice has a more pronounced effect when the alternatives under consideration differ greatly in a range from those with very low initial costs but high maintenance costs to systems with the opposite condition. An example is the comparison of a treatment system to pavement cleaning.
A discount rate must be selected. Economists state that the discount rate should be equal to the long-term inflation rate plus the value of money–that is, what you would earn were you to invest those maintenance dollars. A reasonable discount rate commonly used is 10%.
A future cost valued today at a discount rate of 10% has a lower present value than a cost discounted at 5%. Hence, a lower discount rate results in long-term maintenance costs that have a greater impact on the decision. Companies are likely to use higher discount rates than agencies as the former value money more in the sense of the potential to invest in alterative ways.
Examples of Calculating Present Value
Example 1: Analysis of a System With Constant Annual Costs. The simplest analysis is of a facility that incurs essentially the same maintenance cost each year. Manufactured systems commonly must be maintained annually, or perhaps more often during the year, but the annual cost does not vary much. The same might be said of swales. Opportunity costs and the loss of taxes are not included in these examples.
Assumptions:
- Initial cost including overhead: $125,000
- Annual maintenance cost: $3,000
- Useful life: 20 years
- Discount rate: 10%
The factor used to adjust a constant stream of future costs over 20 years at 10% is 8.51. This is called the present value factor. For 10, 30, 40, and 50 years the factors are about 6.14, 9.43, 9.78, and 9.92, respectively. Using 20 years, we have the following calculation. Present value factors for other years, discount rates, and other related factors presented here are available in the appendices of textbooks on engineering economics.
Present value:
- Initial cost = $125,000
- Constant stream of maintenance costs = 8.51 x $3,000 = $25,530
- Total = $150,530
Were the future stream of costs not discounted, we would have a total sum of $185,000. Note that if 50 years is used, the present value rises to only $154,760. The difference is extremely modest because a cost incurred 50 years in the future discounted at 10% has little present value today. If a discount rate of 5% is selected, the difference between 20 and 30 years becomes more pronounced.
Example 2: Analysis of a System With Periodic Cost Spikes. The above analysis becomes complicated with systems that require a relatively constant annual cost but periodically incur very substantial costs. An example is a wet pond.
A wet pond has annual costs associated with landscape maintenance, litter removal, and vector control. Perhaps once every two years the forebay is cleaned, and once every 10 years the main body of the pond is dredged. Another example is some type of filter using sorptive media. The media must be periodically replaced with sorptive site exhaustion.
Assumptions:
- Initial cost including overhead: $125,000
- Annual maintenance cost: $1,000
- Periodic additional maintenance cost of $10,000 each 10 years
- Useful life: 20 years
- Discount rate: 10%
We need an adjustment factor for each periodic expense at 10-year intervals. This factor is also called the present value factor, but for a single expense at some distant time. For years 10 and 20 these factors are about 0.39, and 0.15, respectively, for the discount rate of 10%.
Present value:
- Initial cost = $125,000
- Constant stream of maintenance costs = 8.51 x $3,000 = $25,530
- Periodic costs = 0.39 x $10,000 + 0.15 x $10,000 = $5,400
- Total = $155,930
The analysis shows that the effect of future periodic costs is modest, again because of the dramatic effect of the discount rate. If the discount rate is taken as 5%, the effect of future periodic costs is much more significant. In the case above, the present value of the periodic costs becomes about $12,200.
Still, in the example shown, the future cost of $30,000 is relatively modest in present value and may have a modest impact on the decision.
But again, the regulator conducting such an analysis must take into consideration that the future periodic cost will be very real, in present value so to speak, when it is required, which may profoundly affect the owner’s willingness to do the maintenance. How does the regulator take this into consideration?
Perhaps the regulator could reduce the discount rate. It could be argued that since in the mind of the owner there is no value in putting the money into some investment as viewed by the economist, the discount rate should only reflect inflation.
Given uncertainties, the analysis can consider different values for the useful life of the facility and different discount rates to ascertain if the outcome is sensitive to judgments with either input.
Example of Calculating Annualized Cost Analysis
An alternative method is to calculate the annualized cost. To make this calculation, the engineer annualizes the initial cost–that is, spreads that cost over the selected facility life. Added to this annualized initial cost are the annual maintenance costs. Again, the analysis can be done for a system with a constant annual cost or one that also has periodic additional costs. This format may be better understood by citizens and elected officials, as it can be viewed in terms of annual budgets.
Example 3: Analysis of a System With Constant Annual Costs.
Assumptions:
- Initial cost including overhead: $125,000
- Annual maintenance cost: $3,000
- Useful life: 20 years
- Discount rate: 10%
The factor used to annualize the initial cost is called the capital recovery factor. For 30 years at 10%, it is 0.117. For 10, 30, 40, and 50 years the factors are about 0.131, 0.106, 0.102, and 0.101, respectively. One can see that there is little reason to go beyond 20 years in the assumptions. Using 30 years, we have the following calculation.
Annualized cost:
- Initial cost = 0.117 x $125,000 = $14,650
- Constant stream of maintenance costs = $3,000
- Total = $17,650
Were the initial cost simply divided by 20 years, the annualized cost would be about $6,000. The higher value in the above calculation reflects the value of money. Note that if 50 years is used as the useful life, the annualized cost is $12,500. The difference again may be modest when comparing alternatives. If a discount rate of 5% is selected, the annualized initial cost is less because we are saying the value of money is less. The difference between 20 and 50 years becomes more pronounced for the lower discount rate. As before, a local regulator may use a lower discount rate for the reasons stated previously. Stated differently, the annualization of the initial cost is in effect what is spent over time were the facility paid for over time. In this analysis, a public owner might use the cost of the bonds sold to support the project, which are paid back by utility fees.
The above method might be used when comparing structural to nonstructural options: for example, a regional treatment facility compared to pavement cleaning. A regional treatment facility has a relatively higher initial cost with relatively low maintenance costs. In contrast, a pavement cleaning program has a modest initial cost and periodic equipment replacement costs, but substantial annual operation and maintenance costs.
The regulator may want to somehow factor in the reality of the difficulty of obtaining the necessary budget each year for maintenance costs, and might therefore select a system with a higher life-cycle cost because the particular system has a lower maintenance cost, irrespective of the life-cycle cost. There are situations in which the lowest life-cycle cost may be of little interest, such as when the owner wants the system with the lowest maintenance cost irrespective of the initial cost or the life-cycle cost. The reason is that in many situations it is easier to obtain the upfront construction dollars than the maintenance dollars. This is often the case with state departments of transportation. It is also likely to be the case for residential and commercial facilities, although the jurisdiction would have to mandate selection of the system with the lowest cost from the systems that are suitable for other reasons (e.g., land space). Although company owners prefer a lower initial cost, needing a relatively quick payback, they may with presentation of the alternatives choose a system with a higher cost but not necessarily the highest.
Life-cycle costing can be an effective way of choosing between systems on a cost-basis.