New generation whole-life costing : property and construction decision-making under uncertainty

223 Pages·2006·21.697 MB·English

by  Ian Ellingham, William Fawcett

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Ian Ellingham and William Fawcett
First published 2006 by Taylor & Francis
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
Simultaneously published in the USA and Canada
by Taylor & Francis
270 Madison Avenue, New York, NY 10016, USA
Taylor & Francis is an imprint of the Taylor & Francis Group, an informa business
© 2006 Ian Ellingham and William Fawcett
This edition published in the Taylor & Francis e-Library, 2007.
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book and cannot accept any legal responsibility or liability for any efforts or omissions that may be made.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
Ellingham, Ian.
New generation whole-life costing / Ian Ellingham and William Fawcett.
p. cm.
“The ideas in this book crystallised in the course of two research projects which were supported from 1998 to 2002 by the
Partners In Innovation (PII) programme for construction industry research, which was an initiative of the UK Department of
Trade and Industry”—Foreword.
Includes bibliographical references and index.
ISBN 0-415-34657-6 (hbk : alk. paper) — ISBN 0-415-34658-4 (pbk : alk. paper) 1. Building—Estimates—Case studies. 2.
Life cycle costing—Case studies. 3. Buildings—Great Britain—Maintenance and repair—Cost effectiveness—Case studies.
I. Fawcett, William. II. Title.
TH437.E454 2006
692'.5—dc22
2006000853
ISBN 0-203-62442-4 Master e-book ISBN
ISBN10 0-415-34657-6 ISBN13 978-0-415-34657-3 (hbk)
ISBN10 0-415-34658-4 ISBN13 978-0-415-34658-0 (pbk)
ISBN10 0-203-62442-4 ISBN13 978-0-203-62442-5 (ebk)
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Introduction and acknowledgements ix
Foreword: Familiar words and new concepts xiii
1 The rationale for project evaluation 1
2 Evaluating long-term projects 9
3 Evaluating risky projects 23
4 Data for whole-life costing 41
5 Lifecycle options 65
6 The option to develop 79
7 The option to expand 95
8 The option to switch use 107
9 The option to reconfigure 121
10 The option to refurbish 137
11 Options on new technology 153
12 Very long-term projects 165
13 Lifecycle budgeting under uncertainty 175
14 Self-assessment matrix for whole-life evaluation 189

Where to find out more 199
Index 205
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1.1 Consumption or investment 3
1.2 Sustainability and efficient investment 4
1.3 Descriptive and normative models 7
2.1 Simple payback 10
2.2 Service life 12
2.3 Cashflow 13
2.4 Time preference 14
2.5 Discounting: cash value and present value 16
2.6 Whole-life costing / lifecycle costing 20
3.1 Fifty years is a long time 24
3.2 Uncertainty 26
3.3 Fan of uncertainty 27
3.4 Binomial tree 28
3.5 Expected value 30
3.6 Volatility 32
3.7 Risk aversion 34
3.8 Risk-adjusted discount rates 35
3.9 The sequence of future decisions 38
4.1 The endowment effect 42
4.2 Inflation: real prices and nominal prices 44
4.3 Opportunity cost 49
4.4 Risk-free rate, risk premium and risk-adjusted discount rate 50
4.5 Weighted average cost of capital 55
4.6 Transaction costs 59
5.1 Embedded and a cquired options 67
5.2 Financial options and real options 69
5.3 Call and put options 73
5.4 Nick Leeson and other disasters 75
vi New generation whole-life costing
8.1 Commercial rent processes 108
8.2 Simulation 111
8.3 Correlation 113
9.1 The value of commercial property 126
10.1 Organisational structure makes a difference 150
11.1 Net benefit, value and option value 160
11.2 Financial appraisal of sustainable investment 162
12.1 The option value of generic technology 167
12.2 Rising wealth hypothesis 171
13.1 Time-to-failure distribution 177
14.1 Completing the self-assessment matrix 193
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2.1 Simple payback 11
2.2 Discounting 15
2.3 Net present value of a cashflow 17
2.4 Whole-life costing 19
2.5 Effect of the discount rate 21
3.1 Retrospective whole-life costing 25
3.2 Binomial tree 29
3.3 Expected value 31
3.4 Volatility 33
4.1 Inflation 45

4.2 Cashflows that increase or decrease over time 47
4.3 Capital asset pricing model (CAPM) 53
4.4 Weighted average cost of capital (WACC) 56
4.5 Internal rate of return 61
New generation whole-life costing vii
5.1 Comparing uncertain outcomes 71
6.1 Standard whole-life costing 80
6.2 Binomial tree of future rents 83
6.3 Present value from a binomial tree 85
6.4 Valuing the one-year option to develop 87
6.5 Valuing the 10-year option to develop 88
6.6 Interpreting the binomial tree 91
7.1 Valuing the option to expand 100
8.1 Simulation of the rental scenario 112
8.2 Cashflow and present value for a rental scenario 114
8.3 Monte Carlo simulation 116
9.1 Simulation of tenancies 124
9.2 Simulation of occupancy 127
9.3 Value of the option to reconfigure 129
10.1 Using historic data to calibrate the binomial tree 141
10.2 Present value of a binomial tree of cashflows 143
10.3 Valuing the option to refurbish 144
10.4 Holding or exercising the option 147
11.1 Binomial trees for a photovoltaic installation (1) 157
11.2 Binomial trees for a photovoltaic installation (2) 159
13.1 Simulation of component replacement cashflow 182
14.1 Self-assessment form 196

viii New generation whole-life costing
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This book is the outcome of two research projects supported by the UK government’s
Partners In Innovation research programme. An initial study of sustainable refurbishment led
to an investigation of new approaches to whole-life costing. The PII projects involved a
constructive partnership between government, researchers, property owners and
professionals.
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The ideas in this book crystallised in the course of two
research projects which were supported from 1998 to 2002
by the Partners In Innovation (PII) programme for
construction industry research, which was an initiative
of the UK Department of Trade and Industry. Curiously,
the questioning of traditional forms of project appraisal
emerged in the first project, ‘Evaluating sustainable
investment in ageing building stock’, which was directed
at understanding issues of sustainability in the renewal
or refurbishment of a mature built environment, as found
in many parts of Europe. Many questions were raised
about how investments in the building stock are or should
be assessed, and the long-term perspective of the
sustainability agenda led naturally to the topic of whole-
life costing. The low take-up of established techniques of
whole-life costing led to speculation about innovative
approaches, and these ideas were explored in the second

project, ‘New generation whole-life costing’.
The PII programme emphasised the dissemination of
findings to industry, not the accumulation of academic
research reports. This book follows the same practical,
applications-oriented approach. There are innovative
ideas, but they are put forward as simple and straight-
forward ways of helping people who are active in the