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 hoopcurrentlycost $9.The inflation rate is expected to be 2% per year, and the prices ofbothhula hoops and hula hoop inputs are expected to increase at the inflation rate. The tax rate is 34%.

(a)Given the risk associated with producingfor the hula hoop market, HHI management believes that a 5%realdiscount rate is appropriate.Whatnominaldiscount rate should be used?

(b)Compute the net incrementalnominalpost-tax cash flows resulting from the purchase of the hula hoop machine on a year-by-year basis for years 1, 2,and 3 (i.e.,t= 1, 2, and 3).You can assume that the initial investment of $1,200,000 is made today (t= 0).

Year 1: _______

Year 2: ________

Year 3: ________

(c)Compute the NPV of the hula hoopmachine.

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.

(e)An increase in the projected inflation rate.

(f)A revised forecast where hula hooppricesincrease at a slower rate than the general inflation rate.