Arizona State University FIN FIN 40628 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…
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?
(b) Compute the net incremental nominal post-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).
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