Critical Chain - Eliyahu M. Goldratt [96]
"It does," Don corrects him. "We always have more investment opportunities than available money. Charlene, would you recommend using net-present-value as a criteria?"
"No," she answers. "It is a more sophisticated method, but I'm afraid that it's conceptually wrong."
Don straightens in his chair. That is also his opinion, but up until now, every financial expert tried to persuade them that net-present-value was the only prudent way to justify investments.
"Net-present-value is the way to translate future investments and income into terms of current money," Don repeats the arguments he's heard so many times. "This method takes into account that interest and inflation exist; that one hundred dollars invested or earned next year are not equal to one hundred dollars invested or earned today. What's wrong with it?"
"You just said it," Charlene answers. "To estimate the value of investment this method uses interest, but we just said that as long as availability of money is a constraint, interest is not the appropriate measure."
"But isn't that what interest is all about." Rick doesn't understand. "If the bank charges me ten percent interest per year, isn't that the price I have to pay for holding the money?"
"Rick, go to the bank, offer to pay them, not ten percent, but twenty. Will they lend you a hundred thousand dollars?"
"Not without collateral," Rick admits, not revealing that is exactly what happened to him yesterday. Before Judith finishes the medical procedures, he may need more than one hundred thousand. Where can he possibly get it?
"You see," Charlene concludes. "The availability of money, which is at the heart of Don's question, has little to do with interest."
"Agreed," says Don. "We at UniCo are not pleased with either payback or net-present-value methods." With little hope, he asks, "Do you have a better alternative?"
"I think so," Charlene answers. "But I'm afraid you won't like it."
"Why not?"
"Because it necessitates developing new intuition."
Everybody waits for her to explain.
"We've just agreed that the availability of money is key for judging between investment alternatives. It is not difficult to prove that time is as important. If time were not part of the equation, if the return were immediate, we would not face any problem. We would invest in one alternative, get the immediate payback, and then invest in the other. We are dealing here with a two-dimensional problem, time and money."
"That's obvious," Don says.
"It is," Charlene agrees, "but we think in terms of time or money. We are not used to thinking in terms of time-money. Look at the methods we just rejected. Payback period is trying to give the answer in terms of time—two-years, three-years payback. Net-present-value is trying to give the answer in terms of money, of dollars. I'm afraid that the answer can only be expressed in terms of time and money, together, not separate."
"I don't understand," Don says.
"Let me give you an example from another field. There are things in reality that are very important. Nevertheless, since they involve summation of multiplications of two different dimensions, we have a hard time understanding them."
"I definitely have a hard time," Johnny interrupts. "Can you repeat that please?"
"Physicists know that one of the most important rules is conservation of momentum. They know that the summation of the masses of all the parts in a system, each multiplied by their corresponding velocity, is conserved, no matter what happens inside the system. Still, people outside physics have a hard time understanding this concept."
"I'm afraid that doesn't help me much," Don grins. "Can you give us a simpler example?"
"Suppose you have a field scattered with rocks. Do you agree that it is interesting to know the effort required to clean the field?"
"For some people . . ."
"How can we evaluate the efforts? We have to know the weight of each