Lifetime cost is an estimate of how much an item, such as a car, a home, or a piece of industrial machinery, will cost to own over its expected useful life. It also includes the initial purchasing cost.
Key Takeaways
- The lifetime cost of an item includes its initial purchase price plus the cost of operating and maintaining it over its expected lifetime.
- Lifetime cost is also known as whole-life cost, life cycle cost, or total cost of ownership.
- Lifetime costs can significantly exceed the purchase price, making them crucial in the decision-making process.
- Opportunity cost pertains to what a consumer or business could have gained by using the money for a different investment.
Mastering Lifetime Cost Calculations
Businesses often calculate lifetime costs before significant expenditures, upgrades, or renovations. For instance, if buying a new piece of machinery, companies will not only consider the initial purchase price but also the operating and maintenance expenses over its expected lifespan.
Individual consumers might find lifetime cost calculations beneficial when buying a home, car, or other expensive items. Besides the initial purchase price, lifetime costs can include:
- Maintenance expenses
- Insurance costs
- Potential renovation or upgrade costs
As an example, if someone buys a luxury coat, the lifetime cost would encompass the purchasing price and the costs of cleaning, storing, insuring, and maintaining it.
In many cases, lifetime costs can far surpass the initial purchase price. For instance, boat owners often find the saying true that a boat is “a hole in the water into which you throw money.”
In addition to lifetime cost, considering the opportunity cost can be valuable. Opportunity cost refers to the potential benefits forgone by investing money elsewhere.
The Impact of Debt on Lifetime Cost
Debt repayments can considerably add to lifetime costs. For instance, financing an item through a credit card or line of credit can result in higher lifetime costs due to interest and fees. Unless repaid promptly, the lifetime cost increases notably.
The most significant example for consumers is usually purchasing a home. A $300,000 home with a 20% down payment and a 30-year mortgage at a 7% annual percentage rate can end up costing around $635,445, accounting for both the principal and interest, doubling the initial purchase price.
Beyond mortgage costs, homeowners also face other lifetime costs, including property taxes, homeowners insurance, and routine maintenance, not to mention the opportunity cost of possibly investing the money elsewhere.
$130 Billion
That’s the estimated total amount Americans pay annually in credit card interest and fees, according to the Consumer Financial Protection Bureau. Credit card purchases can significantly add to lifetime costs unless the monthly balance is paid in full.
Real-World Example of Lifetime Cost
When purchasing a car, buyers often compare different makes, models, features, and dealer offers. However, the costs extend beyond the dealership. Regular expenses include gas, oil changes, auto insurance, licensing, vehicle inspection fees, roadside assistance plans, car washes, and parking fees.
Budgeting wisely involves looking at both the vehicle’s initial cost and its ongoing expenses. Some cars may be more affordable initially but costlier to maintain, while others may have higher upfront costs but lower annual expenses, making them a better long-term investment. The U.S. Department of Energy offers an online Vehicle Cost Calculator to compare the operating costs of different vehicle models.
According to the American Automobile Association (AAA), the average new car costs $10,728 per year to own and operate, encompassing loan finance charges, gasoline, maintenance, insurance, license and registration fees, and depreciation.
Understanding Depreciation
Depreciation is an accounting method used to allocate the cost of an asset over its expected useful life. For instance, office equipment expected to last five years would depreciate by 20% each year. Depreciation plays a vital role in estimating an item’s lifetime cost.
The Depreciation Rate of Cars
Car depreciation rates can vary significantly among different models. Generally, a new car loses about 20% of its value in the first year and another 10-15% each subsequent year over the next five years.
Unveiling Residual Value
Residual value refers to the worth of an asset after full depreciation for accounting purposes. Despite being fully depreciated, an item may still have resale value. For example, a car may still possess trade-in value after several years of use.
The Bottom Line
Understanding the lifetime cost is pivotal for estimating the overall expenses of an item and is especially crucial for high-ticket purchases. Allocate time and resources to evaluate both lifetime and opportunity costs, ensuring informed and financially sound decisions.
Related Terms: whole-life cost, total cost of ownership, life cycle cost, opportunity cost, depreciation, residual value.
References
- Consumer Financial Protection Bureau. “CFPB Report Finds Credit Card Companies Charged Consumers Record-High $130 Billion in Interest and Fees in 2022”.
- American Automobile Association. “Your Driving Costs 2022”, Page 1.
- Capitol One. “Is There a Standard Car Depreciation Formula?”
