Delta Widget Corp. (DWC) is considering whether to purchase immediately a new widget-producing machine at a cost of $1,000,000. The machine would produce 100,000 widgets per year for four years, and would be depreciated for tax purposes at a rate of $200,000 per year. Delta expects to sell the machine at the end of four years. The salvage value based on current price levels would be $300,000, but the actual salvage value four years from now will increase from that level proportional to accumulated inflation. Currently, widget prices are $26, while the materials and labor required to purchase a widget cost $22. The inflation rate is forecast to be 5% per year, and the prices of both widgets and widget inputs are expected to increase at the inflation rate. The income tax rate is 34%, while the capital gains tax rate is 25%. Other than the cost of purchasing the machine now, all cash flows occur at the end of each year.

(a) Given the relatively low risks of producing for the widget market, DWC management believes that a 2% real discount rate is appropriate. What nominal discount rate should be used?

(b) Compute the net nominal post-tax cash flows resulting from the purchase of a widget machine on a year-by-year basis.

(c) Compute the NPV of the widget machine.

Identify whether each of the following would (other things equal) increase or decrease the NPV of the widget machine, and briefly explain why no computations are required:

(d) An increase in the real discount rate.

(e) An increase in the forecast inflation rate. (Note, there are two contributors here identify both for full credit).