Foundations of the Net Present Value Rule
Figure 2-1 illustrates the problem of choosing between spending today and spending in the future. Assume that you have a cash inflow of B today and F in a year's time. Unless you have some way of storing or anticipating income, you will be compelled to consume it as it arrives. This could be inconvenient or worse. If the bulk of your cash flow is received next year, the result could be hunger now and gluttony later. This is where the capital market comes in. It allows the transfer of wealth across time, so that you can eat moderately both this year and next.
The capital market is simply a market where people trade between dollars today and dollars in the future. The downward-sloping line in Figure 2-1 represents the rate of exchange in the capital market between today's dollars and next year's dollars; its slope is 1 + r, where r denotes the 1-year rate of interest. By lending all your present cash flow, you could increase your future consumption by (1 + r)B or FH. Alternatively, by borrowing against your future cash flow, you could increase your present consumption by F/(1 + r) or BD.
Let us put some numbers into our example. Suppose that your prospects are as follows:

|Cash on Hand: |B = $20,000 |
|Cash to be received 1 year from now |F = $25,000 |

If you do not want to consume anything today, you can invest $20,000 in the capital market at, say, 7 percent. The rate of exchange between dollars next year and dollars today is 1.07: This is the slope of the line in Figure 2-1. If you invest $20,000 at 7 percent, you will obtain $20,000 x 1.07 = $21,400. Of course, you also have $25,000 coming in a year from now, so you will end up with $46,400. This is point H in Figure 2-1.
What if you want to cash in the $25,000 future payment and spend everything today on