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Stock Replacement Strategy

Life Cycle Costing Methodology

The general theory of the Life Cycle Costing methodology is based on analysis of the overall product cost that includes acquisition/ initial cost, material cost, operation cost, maintenance expense, salvage value at the end of useful life or any other specific product related cost throughout the useful life of the asset. The analysis is based on different assumption which includes assumed escalation rate, inflation rate, tax rate, depreciation and many more. Future outflows are being discounted and expressed in today’s dollar value. (Source- Life Cycle Cost Guidelines)

The analysis also helps in comparing two different available options and select the one with least cost or more profitability. This is one of the major benefits of LCC. Along with the same it is helpful to prepare accurate budget for any new start or new decision. The limiting part of the LCC can be the large amount of data need and base of framing the assumption.

Here life cycle costing of two products are required to be analyzed which are i) LCC for gas fitter business of a product 4 burner cooktop range (item 58) and ii) LCC for furniture supplier of a product Rectangular hotel type desk of medium size (item 98).

Assumptions

Following general assumptions are considered for LCC analysis

  • Inflation rate is assumed to be 2.5%.
  • Corporate Tax rate is assumed @30%
  • Discounting rate is considered @5%

The rates are assumed based on the present situation of Australia - Economic Indicators published on “Trading Economics” 

Replacement Strategy

Replacement strategy is generally used to maintain and retain the customer. Different organization follows different replacement strategy. With this strategy, organization replaces new product against the old one. Generally, an organization provides this service without charging any amount if the requirement is as per the condition and within the warrantee period offered by the company. (Stock Replacement Strategy by Gordon Scott, 2019)

Here the company provides replacement at the end of useful life of the products. Here it is assumed that customer will return the old product to the company and will replace with new one. The company will sell the used product at its salvage value.

Maintenance Cost / Other Operating Cost

Maintenance cost refers to the cost of maintaining the asset through out the life of the asset. This concept is used when the asset is acquired. For example if the building is acquired, its maintenance cost like cleaning, watchmen salary, building general electricity, etc, should also be considered for LCC.

Other operating cost refers to the cost which are indirectly incurred for the asset. This concept is as well applicable for asset acquisition.

For the given analysis the products are sold and not acquired accordingly no maintenance cost the entity will incur. However, company may incur some expense during the warranty period of the product.

Further some of the operating cost like delivering the product, depreciation on the pallet truck, carrying cost of the product, etc. will be incurred within first year. In the absence of more information it is assumed here as $5.00 

Product Wise Analysis

Item 58 - 4 burner cooktop range

  • The burner material cost is $6691/- and its installation requires two hours. Generally, the installation services are free for the Assuming hourly rate for installation as $ 30.44 per hour (Source - Average Gas Fitter Hourly Pay in Australia) total initial outflow the company will be $ 6751.88. Further the company will have other operating expenses for the product in the zero year for $5. Thus, total outflow of zero year will be, $6756.88/-
  • It is assumed that the company will provide guarantee for gas burner for two years and one free inspection in each year. Assuming the inspection takes half hour, the cost will be $15.12/- in first year and second year.
  • Further, some of the parts may require free replacement as per the warranty service. Assuming $10 as free replacement cost within first and second year and accordingly considered here.
  • The labor rate at the time of replacement at 20th year is assumed as @40/- per hour.
  • The salvage value of the product at the end of 20th ear is assumed $100/-
  • Considering all these, we can analyses that the life cycle cost of the product will be of around $7647.64/-
  • Company will incur the expenditure within initial 2 years and afterward for every inspection and repairing cost will be chargeable to customer.
  • If we do proportional split, we can analyze the following,

Year

Actual Cost before tax

%

NPCV

%

0

 $ 6,756.88

49.97%

 $ 4,729.82

61.69%

1

 $ 25.12

0.19%

 $ 17.17

0.22%

2

 $ 25.12

0.19%

 $ 16.76

0.22%

20

 $ 6,676.00

49.37%

 $ 2,886.06

37.65%

21

 $ 20.00

0.15%

 $ 8.44

0.11%

22

 $ 20.00

0.15%

 $ 8.24

0.11%

 $ 13,523.12

100.00%

 $ 7,666.48

100.00%

 We can easily identify that initially it seems that the expenditure is higher and almost equal in zero and 20th year, but NPV will shows the exact situation. The same can be represented in chart form as follow,

Item 98 - Hotel Desk, Rectangular; Medium Range

  • Furniture desk is the product that does not require any maintenance cost, installation cost or inspection cost.
  • Warranty period varies based on company from 1 to 5 years. Considering this here 1-year warranty is taken.
  • Assuming no rework requires within warranty period.
  • The salvage value at the end of the product life is taken as $50/-.
  • Considering all these, we can analyze that company will provide replacement of the product two times during the life cycle i.e. in the 15th year and 30th Accordingly, material cost will be incurred thrice during the life cycle. On the detailed analysis we can have the idea that the actual expenditure of the company will be even lesser than twice the expenditure. The proportionate spilt will further guide in this regard,

Year

Actual Cost before tax

%

NPCV

%

0

 $ 884.00

34.64%

 $ 618.80

47.28%

15

 $ 834.00

32.68%

 $ 406.71

31.07%

30

 $ 834.00

32.68%

 $ 283.34

21.65%

 $ 2,552.00

100.00%

 $ 1,308.84

100.00%

  • This help us to have clear picture of the future outflow. Initially the expenditure looks thrice but in actual it is not. The flow chart will further clear the concept.

Thus, LCC methodology is one of the best methods to have clear understanding of future outflow. It helps to control future expenditure and meet the targeted profitability. Perhaps, this is the main reason for major use of LCC within oil, gas, energy generation, building construction etc. It represents clear result in a consistent format.

References for Life Cycle Costing Model

Life Cycle Cost Guidelines (2019, July 8th), published by Department of Local government, sports and cultural activities available at (https://www.dlgsc.wa.gov.au/department/publications/publication/life-cycle-cost-guidelines)

Australia - Economic Indicators published on “Trading Economics” (https://tradingeconomics.com/australia/indicators)

Stock Replacement Strategy by Gordon Scott, (2019, July 27) published on Investopedia available at (https://www.investopedia.com/terms/s/stock_replacement_strategy.asp#:~:text=Stock%20replacement%20is%20a%20trading,stock%2C%20almost%20dollar%20for%20dollar.)

Average Gas Fitter Hourly Pay in Australia published on PayScale (https://www.payscale.com/research/AU/Job=Gas_Fitter/Hourly_Rate)

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Management Assignment Help

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