The Environmental Protection Agency has ordered your oil-refinery to process its

Question

The Environmental Protection Agency has ordered your oil-refinery to process its waste liquids before discharging them into the local bay. You estimate that it will cost you $30,000 to satisfy this requirement this year. However, by gradually making no cost adjustments in the refining process, you estimate you can reduce waste processing costs by 5% annually over the next 10 years, which is the remaining life-time of the refinery. On the other hand, an outside company has offered to process you waste for you every year for the next ten years at an annual fee of $15,000. If your company used 10% discount rate, which is the preferred course of action?

Explanation / Answer

Am I missing something here? Even if you can reduce your waste processing costs 5% per year from the initial amount of $30,000, they will still be above $15,000 every year of the ten. So it would obviously make more sense to pay the outside firm $15K a year.

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