Reference no: EM133030047

Question - Song Hye Kyo recently retired as an actress and is interested in opening a fitness gym and health spa in the Cayman Islands, where she plans to reside. After a careful study, she was puzzled whether to put up the gym and spa all at once or have the health spa started first before the other.

Some of the information is available below:

1. Hye Kyo has identified a location for her business in a new shopping center in the city of Cayman. The developer has units of 500 sq feet and 1000 sq feet available and is willing to sell either unit of USD 150 per sq foot. Alternatively, she can lease the space for USD1.80 per sq foot per month on an annual basis.

2. Value of commercial real estate is more likely to appreciate so Hye Kyo is looking at purchasing the unit as she expects that the price of the unit will be USD300 after 10 years.

3. Exercise machines and other necessary equipment to open the gym would be USD25,000. In addition, USD20,000 would need to be invested in the spa. The expected useful life of the equipment is 10 years.

4. In addition, USD4,500 needs to be invested in the inventory of cosmetics and skin products necessary to operate the health spa. This level of inventory would need to be maintained throughout the 10-year period and will be given away to loyal customers when Hye Kyo retires permanently.

5. The health spa can be operated in a 500 sq feet unit. Variable operating costs would include USD0.10 per sq foot per month for cleaning and USD0.40 per sq foot for utilities. The 1000 sq feet is large enough to operate both the health spa and fitness center, same cost for cleaning per sq foot. However, if 1000 sq feet will be used, the health spa has to be in an open loft, which means it has to be air-conditioned at all times. As a result, the utility expense is USD0.60 per sq foot under this option.

6. Hye Kyo is a certified aesthetician and is expected to do most of the makeovers, facials, and peels herself, but she needs an assistant. She estimates the salary of the qualified assistant to be USD17,000 per year. She also needs to hire 2 gym instructors for USD15,000 per year each and a physical trainer for USD22,000 per year for her fitness gym.

7. Additional fixed costs include USD1,500 per year for advertising and USD3,000 per year for maintenance, insurance, and other items. These costs will incur without the size of the operations.

8. Annual membership fees to the fitness center will be USD250 and a preliminary market survey shows a demand of approximately 500 initial members. Although members tend to come and go, the net change of members per year is not that significant. No additional fee will be charged to fitness members.

9. Health spa fees are assessed per user basis, although the steam room facilities are available at no charge to fitness center members. The net cash flow from cosmetics to skincare products (After deducting the cost of inventory used and sold) is expected to be USD6,000 per month.

10. Hye Kyo's cost of capital is 12% and no tax in the Cayman Islands.

Required -

1. How much is the initial capital Hye Kyo will invest in the first year for Health Spa? How much for the fitness gym?

2. Compute the net present value for the investment of health spa only given that 500 sq feet were purchased and resold after 10 yrs.

3. Compute for the net present value for the investment of health spa and fitness center given that 1,000 sq feet were purchased and resold after 10 yrs.

4. Provide your recommendation to Hye Kyo on which option she will choose. Keep in mind that Hye Kyo has not given herself salary on the whole projections. Assume that her reasonable salary per month is USD10,000.