Introducing capital budgeting

I have here in my little hand a special little machine. Okay. What does it do? It creates money. Okay. How much money? This little machine here creates exactly one U.S. dollar per year. Completely legal. The dollar bill pops out of this hole at midnight on December 31st, every year. Are you sure this is legal? Absolutely. Now, the question is, how much would you pay me for this little machine? Let me look at it. How long is it going to last? That's the good news. This little machine is guaranteed to last one billion years. Yes, in it's useful lifetime, this machine will produce a total of one billion dollars. A billion dollars. So how much will you pay me now? This billion-dollar machine, how much will you pay me today? I'm not going to pay you a billion for it, that's for sure. 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 percent, is that okay? Okay, 10 percent. Sure. If the interest rate is 10 percent, 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.