Reference no: EM132979138

CC Fitness owns and runs two local gyms. Last year the largest branch made sales of RM500,000 but as member numbers are declining, they are thinking about refurbishing the gym and upgrading the equipment.

The expected costs and benefits of the refurbishment are as follows

i) New fitness equipment would cost RM450,000 to buy and install. This includes a refurbishment of the gym space.
ii) Sales are expected to rise to RM550,000 in Year 1 if the changes are made, thereafter increasing by 5% per annum. If the changes are not made sales are expected to fall by RM40,000 per annum.
iii) Depreciation would be provided at RM90,000 per annum.
iv) The manager of the gym has been to a conference to research the new equipment and receive training on the safe use of the equipment. The cost of the conference was RM3,000. A further RM20,000 would be spent on training the rest of the gym staff if the equipment was purchased.
v) It is anticipated that electricity costs would rise by 5% of the total sales as a result of extra running costs of the new machines.
vi) The manager of the other fitness center would be required to cover the running of the gym when the new equipment is first introduced, while the current manager trains the remaining gym staff. It is anticipated he would stay for one month. He is paid an annual salary of RM48,000. He would not be replaced at the other fitness center during this month.
vii) A 5 years maintenance contract would be entered into at a cost of RM10,000 per annum.
viii) Interest on money borrowed to finance the refurbishment would be RM 6,000 per annum.
ix) CC Fitness's required rate of return is 10% per annum.

Required:

Problem a) Discuss what capital investment means for CC Fitness. Your answer should be supported with relevant example.

Problem b) State whether each of the following items is relevant or irrelevant cash flows for a net present value (NPV) evaluation of whether to refurbish the gym.

i) Investment of RM450,000 in the new equipment
ii) Depreciation of RM90,000 over each of the five years
iii) Staff training costs of RM20,000
iv) Temporary manager's salary of RM4,000
v) Conference and staff training costs of RM3,000
vi) Interest costs of RM 6,000 per annum

Problem c) Calculate the following values if the gym is refurbished:

i) Incremental sales in Year 1
ii) Present value of the maintenance costs over the life of the contract
iii) Additional electricity costs in Year 1