- I have here in my little hand, a special little machine.
Nah!
- Okay, what does it do?
- It creates money.
- Okay, how much money, money?
- This little machine here creates
exactly one US dollar per year, completely legal.
The dollar bill pops out of this hole
at midnight on December 31st every year.
- Are, are you sure this is legal?
- Absolutely!
Now the question is, how much would you pay me
for this little machine?
- (whispers) Oh, let me look at it.
(speaking normally) How long's it going to last?
- That's the good news!
This little machine is guaranteed to last one billion years.
Yes, in its useful lifetime, this machine will produce
a total of one billion dollars.
- A billion dollars?
- Yep, so how much will you pay me now?
This billion dollar machine, how much will you pay me today?
- Ah, I'm not going to pay you a billion dollars for it,
that's for sure.
- Ah, why not?
This will completely recover
your billion dollar investment over the life of the machine.
You pay me a billion dollars now for it,
you'll eventually get your entire billion dollars back.
- Yeah, but I'll have to wait a billion years.
Plus a dollar now is not worth the same
as a dollar a billion years from now.
- Exactly, you've hit on the key concept here.
It's called the time value of money.
A dollar now is worth more than a dollar to be received
five years from now, or 30 years from now,
or a billion years from now.
So when you are evaluating long-term projects,
a process called capital budgeting,
you have to consider the time value of money.
- Okay, so what would be a fair price
for your billion dollar machine?
- Well, let's say the appropriate interest rate is 10%,
is that okay?
- Okay, 10%.
- Sure, if the interest rate is 10%,
then an appropriate price for this billion dollar machine?
$10.
- $10 for a billion dollar machine?
Obviously, we need to learn more about capital budgeting.