As we learned in Chapter 9, the basic rule to follow when deciding whether or not to undertake a project is to compare the benefits of the project with its costs—explicit as well as implicit—and choose the course of action with the higher economic profit.

But many economic decisions involve choices in which the benefits and the costs arrive at different times, making comparisons between those choices more difficult. Ashley’s decision, whether to go back to school and get an advanced degree or to get a job, is one of those types of comparisons. If she chooses to get an advanced degree, the costs—forgone wages, tuition, and books—are incurred immediately, while the benefits—higher earnings—are reaped in the future. In other cases, the benefits of a project come earlier than the costs, such as taking out a loan to pay for a vacation that must be repaid in the future. So how should we make decisions when time is a factor?

The economically correct way is to use a concept called present value. Using present value calculations allows you to convert costs and/or benefits that arrive in the future into a value today. This way, we can always compare projects that occur over time by comparing their values today. You might wonder why you didn’t see present value calculations when we analyzed Ashley’s decision in Chapter 9. The fact is that present value was used, but implicitly. For example, statements like “she will receive earnings from her degree valued today at $600,000 over the rest of her lifetime” mean that the future benefits had already been converted into a value today—that value being $600,000.

Now let’s see exactly how present value works.