15.10 Montfort Spelling plc operates a chain of health clubs. Each year the company opens a club in a new location. For 2013, the company is examining two possible locations:

Broughton Town and Carey City. The directors have collected information about costs and local demographics, and have come up with the following summary of the initial investment required, and cash flows for the subsequent 5 years. The company’s normal policy is to completely refurbish its clubs every 5 years; it remodels and redecorates the clubs and sells off all the old equipment.

Initial outlay includes the cost of taking out a 5-year lease on premises, buying in all the equipment and paying architects and builders to remodel the premises. The net cash inflows from years 1 to 5 include estimated takings in annual subscriptions and joining fees, less the costs of employing staff, and various other fixed costs of running the club.

The table below summarizes the costs for the two locations:

Broughton Town Carey City

£000 £000 Time 0: initial investment (630) (540)

Time 1: net cash inflows 250 242 Time 2: net cash inflows 275 250 Time 3: net cash inflows 280 260 Time 4: net cash inflows 295 270 Time 5: net cash inflows 310 280 Time 5: inflow from sales of equipment 35 30 The initial capital expenditure less the anticipated residual values is to be depreciated on a straight-line basis, in accordance with the company’s policy, over 5 years.

i) Calculate ARR for each project.

ii) Calculate the payback period for each project.

iii) Advise the directors as to which location should be preferred.