When I started at the derivatives desk in JPMorgan in 1999, this was the first thing they taught us. It provides a framework by which decisions can be made in almost any thing – take buying a home for example, or buying/leasing a car – your buying decision is not a function of the purchase price, but rather the present value of all cash flows – what you pay, plus taxes and maintenance less what you get when you sell the home/car. Now add the timing of the cash flows, and then discount it back to today. You can apply this approach to any financial decision to isolate and quantify the trade-offs that you make.

Of course, in many situations the cash flows, timing and discount rate are all uncertain – that’s what makes it fun and interesting, and where other aspects of the framework come into play.

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