Spreading the Gospel of Net Present Value

Your humble blogger studied accounting and finance before the personal computer was invented.

The only electronic devices that we brought to class were calculators that performed basic arithmetic. And so it was that we labored over present value/future value problems, pencilling out intermediate solutions so we at least could get partial credit from the proctor.

After learning how the basic formulas were derived, we were taught how to use books of tables to bypass much of the repetitive drudgery in financial calculations. The future-value table below is from McGraw-Hill.

Until financial calculators and PC's came on the scene, such tables were used in finance for 3½ centuries(!) These tables seem extraordinarily crude today, but when they were first published in the 1600's, it sparked the widespread acceptance of "discounting" as an alternative payment. It wasn't businessmen or bankers who spread the word, but the Anglican church. [bold added]

In the early 1600s, the officials running Durham Cathedral, in England, had serious financial problems. Soaring prices had raised expenses. Most cathedral income came from renting land to tenant farmers, who had long leases so officials could not easily raise the rent. Instead, church leaders started charging periodic fees, but these often made tenants furious. And the 1600s, a time of religious schism, was not the moment to alienate church members.

Interest-calculation book from 1700.

But in 1626, Durham officials found a formula for fees that tenants would accept. If tenant farmers paid a fee equal to one year’s net value of the land, it earned them a seven-year lease. A fee equal to 7.75 years of net value earned a 21-year lease.

This was a form of discounting, the now-common technique for evaluating the present and future value of money by assuming a certain rate of return on that money. The Durham officials likely got their numbers from new books of discounting tables. Volumes like this had never existed before, but suddenly local church officials were applying the technique up and down England.

Spreading the "Gospel of Net Present Value" was one of the most important developments in capitalism. With apologies to the bard,

Neither a borrower or a lender be
But if you are either
Be mindful of the NPV.