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Hula Hoop Inc (HHI)is considering whether to purchase a new hula hoop-producing machine at a cost of $1,200,000.
Hula Hoop Inc (HHI) is considering whether to purchase a new hula hoop-producing machine at a cost of $1,200,000. The machine would produce 100,000 hula hoops per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $400,000 per year. No salvage value is expected. Currently, hula hoops can be sold for $15 each. The materials and labor required to produce a hula hoop currently cost $9. The inflation rate is expected to be 2% per year, and the prices of both hula hoops and hula hoop inputs are expected to increase at the inflation rate. The tax rate is 34%.
(a) Given the risk associated with producing for the hula hoop market, HHI management believes that a 5% real discount rate is appropriate. What nominal discount rate should be used?
Identify whether each of the following would increase or decrease the NPV of the hula hoop machine, and briefly explain why - no computations are required:
(d) An increase in the real discount rate.