I have an ATI Rage Fury Pro video card with on board Rage Theatre hardware MPEG decoder/encoder chip, yet CPU usage while playing DVD in WMP is ~35% and it comes to slowness when I do another task that calls for CPU power. I think it's using Nero software decoder instead of using the hardware decoder.

How do I know my hardware decoder is being used and how do I make sure it gets used instead of software decoder?

Software will only use particular hardware if they know it's there.
ATI tried to make this a good selling point of a range of it's graphics cards, but lack of general support software meant it never really took off.
See ATI's web site to see if there is a DVD player that supports the decoder chip in your card.
P.S. playing DVD's in any computer with less than a 2GHz processor will take a chunk of your processors time, there's a lot it has to do to get it to show on your PC screen!