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Life cycle profit (LCP) analysis

What is a LCP analysis

LCP is the abbreviation for life cycle profit. The main objective of performing a LCP analysis is to achieve maximum profit for an investment in the long run. The basic LCP formula for a single investment is:

 

        

where:

I0   = Investment at the beginning of year 1 
St   = Net cash at the end of year t for investment  
Rn   = Rest value at the end of year n
= Discount rate 
= Investment time period 

The investments is profitable if LCP > 0. High LCP means high profit. There are several analyses closely related to the LCP analysis. That includes Life Cycle Cost (LCC) analysis, Cost/benefit analysis and Net Present Value (NPV) analysis. The ‘LCP value’ is highly dependent on the discount rate and the quality of the cash-flow in the investment period.

This page describes some thoughts related to investments within a company, but also in private where feelings have an even higher importance. 

Why

The LCP analysis will optimise the profit for an investment.

How

Details about LCP performance is not described in this document. This document aims to describe important issues related to the analysis for improved communication between the analysis expert and the people responsible for the result of the analysis.

When

The LCP analysis is often executed as a comparison between investment A and alternative B. Alternative B could be an existing solution or an alternative investment. The alternative with the highest LCP will be chosen. The LCP analysis lies at the very heart of economists since the decision for acceptance or rejection of an investment is based on highest possible profit for the company. The LCP analysis may also be used by persons in their everyday life, like when they are purchasing a new car or TV. The goal will then be most value for money. This is not always the case. Humans are willing to pay for enjoyment and pleasure, like cars with good design and performance and good vine. Life is more than profit. These feelings are however not included in the LCP analysis. Feelings also play an important role in business decision making processes. It is claimed that 80% of the investments within aviation security is based on feelings and not safety or cost/benefit.

Examples

Investors typically use the method for:

  • Oil production or money in the bank
  • Oil production or fish

Oil companies typically use the method for:

  • Platform or subsea
  • Optimisation of platform lifetime
  • Modification of a pump or operation and maintain as planed

Private persons typically use the method for:

  • Buy a car or take the “bus”
  • Buy a car - old or new
  • Buy a car – frequently or infrequently

One-time investments do not require equal time period for the alternatives. Cyclic investments require equal time period for the alternatives. A recommended one-time investment with a time period of 5 years is not necessarily recommended if the life period has to be 20 years and the investment has to be repeated four times. Examples follow:

Further discussion

A production loss analysis will identify costs of losses. A cost analysis at the maintenance department will identify cost-drivers on the maintenance budget. Compressor and power generator failures give high production loss but not necessary be one of the ten-on-top lists of the maintenance cost-drivers. Both analyses are necessary and can be combined in the LCP analysis.

The maintenance department at an offshore platform has a key factor in LCP optimisation. The maintenance department must have good relations to both the operating staff controlling the production and the economists at shore controlling the maintenance and investment budgets. Losses after a shutdown are highly dependent on the reservoir and connection to other platforms. Good communication between the operating staff and the maintenance department is thus of high importance. Old platforms normally have increasing maintenance budgets due to more corrective maintenance. Economists often look at maintenance as a cost only. The maintenance departments should improve their communication with the economists by using the LCP principle to defend or increase their budgets. High cut in the maintenance budget may be a bad strategy. Most companies are learning the ‘hard way’.

LCP cannot be optimised without taking care of HSE requirements and limitations in the maintenance budget. All budgets will have limitations.

Some economists focus on the payback only and ‘forget’ the rest value of the investment. This value will be low for a car but could be the main contributing factor to high profit if the investment is a company.

Updated: 07.01.2013

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