Cost of Borrowing

Personal Finance
Ian Widensky
Ian Widensky
Time Value of Money

Thomas Edison’s Universal Stock Printer

In 1869, Thomas Edison sold his first successful invention, the Universal Stock Printer, for $40,000. The company who purchased this equipment offered to pay Edison in a single payment or several annual payments. Edison opted for the smarter one-time payment. But why was this the better choice?
The decision Edison faced was an assessment of the time value of money – how much was that money worth to him now vs. later? This principle is based largely on risk.
Since money in your pocket is guaranteed, its value is generally perceived to be less than a promised sum that carries a varying degree of uncertainty. Factors such as time, opportunity cost and the integrity of the individual or company responsible for making payments all contribute to the final value.
This is why we expect to receive interest when we invest money or pay interest when we borrow it. The greater the risk or opportunity cost, the more interest we expect to pay or receive.
The company offering to purchase Edison’s invention made the decision easy for him by asking for longer payment terms without offering any interest to offset the risk.  

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