[jarcnc]

Winthrop Company has an opportunity to manufacture and sell a new product for a five-year period. To pursue this opportunity, the company would need to purchase a piece of equipment for $130,000. The equipment would have a useful life of five years and zero salvage value. It would be depreciated for financial reporting and tax purposes using the straight-line method. After careful study, Winthrop estimated the following annual costs and revenues for the new product:

Annual revenues and costs:
Sales revenues	$	250,000
Variable expenses	$	120,000
Fixed out-of-pocket operating costs	$	70,000

The company’s tax rate is 30% and its after-tax cost of capital is 15%. What is the net present value?

I did 250,000 - 120,000 - 70,000 to get 60,000. I took that number by the discount factors (.870, 756, 658, 572, 497). Then added those numbers to get 201,180. Then that minus 130,000 to get 71,180. I don't really understand it.

[ArcSine]

You're on the right track, just need a couple more steps. You've applied the discount factors to the asset's pre-tax annual profits, but you should first compute the after-tax cash flow before applying the discount factors.

First compute the tax expense each year (net profit, less depreciation, times the tax rate). Then deduct this tax from the $60,000 net profit to arrive at the annual net cash flow from the asset.

Hit those after-tax net cash flows with the discount rates.

[paraclete]

Present value determines the value of future cash flows so what you have is a value at an assumed rate of return where cash flows remain constant but the value of money declines over time