Allday Fitness Club (AFC) was founded 23 years ago by a married couple, Tejinder and Taranjit Singh, both professional athletes. They had very specific goals for their fitness center and crafted the following mission for AFC:

AFC aspires to help people in the greater Montreal region to lead healthier lifestyles. AFC will provide members with a personalized weight-training program in a welcoming, enjoyable, and pleasant environment that will allow them to achieve their health and fitness goals.

AFC is a two-level fitness center and has three training rooms on the ground level: a spin studio (for stationary cycling classes), a weight-training room, and a fitness room. The second-floor houses locker rooms with showers and the administration office.

AFC is a small fitness center but the business has been much more profitable than other small fitness centers, mainly because it has a friendly atmosphere and personalized weight-training programs. AFC is open 20 hours a day, seven days a week. AFC employs one administrative clerk and a trainer for the spin classes. In addition to managing the business, Tejinder and Taranjit create personalized weight training programs for each member (diet plans and training schedules) and provide the weight training.

In recent years, recreational fitness activities such as yoga, Pilates, Zumba, and group cardio and strength activities have become very popular. Studies have shown that yoga can help reduce stress and anxiety. People perceive recreational fitness as more enjoyable than traditional weight training. A few major fitness centers already offer these recreational fitness activities and have expanded into group classes to help people prepare for various races.

AFC's members continue to sign up for spin classes and weight training, but Tejinder has noticed that participation in the spin classes has been static for a few years and participation in weight training has declined gradually. Tejinder has always wanted to maintain a profit margin of 10%.

Currently, AFC's facility is too small to simply add new activities. The only way to add activities is to remove the equipment from the weight-training room and combine the fitness and the weight-training room into one.

Taranjit thinks this change in the market is a great opportunity for them to reduce their time spent on weight training and focus on managing the business with a potential increase in staff and class scheduling. Tejinder also thinks that AFC needs to make some changes to remain profitable. The owners believe that they could remain in the weight- training business with minor changes (for example, improve their marketing strategies, add more options to the weight-training programs, increase price for the weight-training membership, and so on), but they would also like to evaluate whether removing the weight-training room and replacing it with recreational fitness activities is a good idea. They are, however, also concerned that this business shift would be drastic and are uncertain of the impact on profitability of the changes over the next five years. Before making any changes, Tejinder would like an idea of how many new recreational fitness members AFC would have to attract to at least cover the expenses initially and over the long term to maintain his target profit margin. Both owners are concerned with the significant capital investment and would like an assessment of whether this investment in recreational fitness is worthwhile and can be recovered within the next five years.

You, CPA, are an external consultant hired by AFC to provide business advice that is supported qualitatively and quantitatively. AFC's administrative clerk has given you last year's unaudited financial information (Appendix I). You have also summarized information about the recreational fitness industry (Appendix II) and the costs of the renovation (Appendix III).

Appendix I

Income statement as of December 31, 2019

Revenues Spin classes $ 79,200

Weight training 368,640

Total revenue 447,840

Expenses Salaries 280,000

Operating expenses (including utilities) 84,000

Advertising expenses 12,000

Depreciation expense 6,500

Total expenses 382,500

Operating profit 65,340

Tax (38%) 24,829

Net income $ 40,511

The price of a spin class membership is $40 per month per member. AFC had 165 members in total for spin classes in 2019.

The price of a weight-training membership is $80 per month per member. AFC had 384 members in total in the weight-training program in 2019. The price includes a consultation and weight-training program for each member.

Membership for the spin classes and weight-training is counted by weighted average; for example, if one person had a membership for six months and two people had memberships for three months each, this is counted as one member in total for the year.

Salaries include $50,000 for a spin class trainer, $30,000 for an administrative clerk, and $60,000 each for Tejinder and Taranjit for the weight-training instruction. Tejinder and Taranjit also receive $40,000 each for managing the business.

The remaining useful life for the weight-training and spin equipment is eight years; depreciation is $5,200 per year for the weight-training equipment and $1,300 per year for the spin equipment.

Appendix II

Information related to the recreational fitness industry

You have been provided the following data by Tejinder and Taranjit, who researched the recreational fitness market and surveyed current AFC members about possible changes. The following table shows the expected numbers of membership: Current Year 1 Year 2 Year 3 Year 4 Year 5

Recreational fitness 0 300(1) 318 337 350(2) 350

Spin classes 165 140(3) 140 140 140 140

Weight training 384 0 0 0 0 0

Note 1: With aggressive marketing, AFC can expect 300 members for recreational fitness activities in the first year.

Note 2: AFC's current facility can accommodate a maximum of 350 recreational fitness members.

Note 3: The member survey showed that spin class memberships will decrease by 15% as a result of renovating the fitness centre for recreational fitness.

The average price for recreational fitness will be $150 per month per member, and the price for the spin class memberships will remain the same.

Tejinder and Taranjit will stop receiving their weight-training salaries; instead, AFC will need to hire four instructors for recreational fitness: each instructor will be paid $55,000 per year and be in charge of several recreational fitness classes.

In addition, if the number of members is more than 330, AFC will need to hire a parttime instructor at $40,000 for an extra class. Tejinder and Taranjit wonder whether it is worthwhile to hire an additional instructor.

Operating expenses are not expected to change.

Advertising expense will be doubled for the first two years, returning to its former level in year 3.

Appendix III

Information related to renovations

You have gathered information from several equipment suppliers and renovation companies. The required capital investments are given below:

Renovation costs for the recreational fitness room $ 150,000

Purchase of recreational fitness equipment $ 15,000

Consultant design fee (related to renovation) $ 7,500

AFC can finance the entire renovation and maintenance costs without borrowing from external sources.

AFC would sell the current weight equipment for $35,000.

For this project, AFC has determined that a risk-adjusted discount rate of 8% should be used.

The useful life of both the renovated facility and the new recreational fitness equipment is five years and both will not have a residual value. Recreational fitness equipment has to be repurchased at the end of year 5 at the same costs.

AFC uses straight-line depreciation.

The tax shields associated with the renovations are $19,211 and the equipment is $3,920.