13.2: The Value of Money

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What does it really cost to purchase a $40,000 car? If you have $40,000 in the bank that you can use to purchase the car, you will need to withdraw it and use it. However, if the bank is paying 4% interest every year, you will no longer receive that yearly interest income of $1,600.

If you do not have the $40,000 in your bank account, you will need to finance the car and pay off the debt over time. Paying for the car with a loan will cost you $40,000 plus interest until it is paid off (usually over 3 to 5 years). Under this scenario, you not only pay the principal and loan interest, but you also lose out on potential earned interest because you do not hold that $40,000 in cash going forward.

Understanding these trade-offs provides a clear model for accounting for how the value of money affects major financial choices. It is equally critical in an engineer’s decision on what equipment to purchase, which design alternatives to select, or which capital projects to fund.

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