Hidden Springs Spa (HSS) is a day spa, operating seven days a week, that offers a variety of services including massages, facials, body wraps, manicures, and pedicures. The spa is situated in a convenient location in the heart of historic downtown Brookfield. There are currently three other day spas in Brookfield, with two of them having opened in the past two years.

HSS was purchased on February 1, 2021, by Karen Tran, a naturopathic doctor, who is well respected in the Brookfield community. Karen was a regular client of the spa before becoming the owner and was aware of its reputation for using quality products. Karen saw a great opportunity to grow the business further by using her expertise to expand the spa's health and wellness offerings.

It is now July 1, 2021, and Karen has had some time to familiarize herself with the spa business and HSS's operations. You, CPA, have performed accounting services for Karen's medical practice in the past, and she has approached you for advice on the new IT system (Appendix II).

Karen explained that while spas in general have benefited from a strong economy and high disposable income in recent years, HSS's revenue per visit is lower than the industry average. This is due in part to the spa's increasing reliance on discounts to attract and retain clients as competition has increased. Karen wants to move away from this approach and instead implement a strategy focused on offering an exclusive, highly personalized experience that will justify a premium price.

HSS is also performing below industry average when it comes to staff utilization that is, the percentage of paid time that therapists and technicians spend performing treatments. Given that labour is the most significant expense for a spa, maximizing staff utilization is critical to improving profitability.

Notes from your discussion with Karen are included in Appendix I.

Task #1

Karen recognizes that HSS's existing IT system is out of date and needs to be replaced. The vendor that developed the system Karen used in her medical practice has offered to customize the same system for a spa application. The vendor, which specializes in software for medical offices, has offered a discount on the customization because it is interested in marketing the system to other spas after it is implemented by HSS. Excerpts from the vendor agreement are included in Appendix II.

Karen has already decided to go ahead with the system based on an agreement with the vendor that it will work to address any concerns she has. She has asked you to help with this by preparing a full analysis of the system.

She would like you to identify any strengths and describe how these align with HSS's objectives. She would also like you to identify any weaknesses and make recommendations on how the system could be improved so that she can address this with the vendor.

Task #2

The vendor is offering two options for acquiring the system. Karen would like you to analyze the options to determine which one would be more cost effective.

Option 1: Lease

Under the lease option, HSS would lease the software and the required hardware from the vendor for a five-year period. The terms of the lease are as follows:

Annual lease payment of $85,000 with the first payment due on signing; includes free upgrades for the term of the lease and use of hardware with sufficient capability to run the system for the term of the lease.

Option 2: Purchase

A five-year software licence can be purchased for $150,000. New hardware will also need to be purchased at a cost of $75,000. The hardware is expected to have a salvage value of approximately $12,000 at the end of the five years.

HSS would have the option of paying for the upgrades at a cost of $10,000 per year, due at the end of each year.

You have confirmed with Karen that HSS has an after-tax cost of capital of 8% and is subject to a corporate tax rate of 23%.

Appendix I - Notes from discussion with Karen Tran

HSS uses high-quality, organic spa products in its treatments and offers the same products for sale to clients to enjoy at home between visits. The retail sale of spa products is an increasing source of revenue for the industry since it is a direct "add on" to spa visits and provides a higher gross margin than treatments and services.

Karen has noticed that the spa frequently runs out of some products and has an excess of others. The receptionist counts the inventory and places an order every two weeks, but sometimes the product is out of stock for several days in between orders.

The staff is highly qualified, and Karen has been impressed with their professionalism and friendliness. There are few qualified therapists in Brookfield, which makes any vacant positions difficult to fill. The therapists and technicians work a fixed schedule that was developed by the previous owner to ensure that the staff on hand at any given time collectively have the ability to deliver every treatment that the spa advertises. Karen estimates that about 75% of spa visits are booked more than a week in advance and 50% are booked more than two weeks in advance.

The receptionist struggles with completing and submitting insurance claim forms for massage therapy treatments. The process can be tedious and time consuming, and it often gets put off while she tends to clients. As a result, billings are often delayed.

Some clients request a particular therapist, and often that therapist is familiar with the client's preferences, such as their preferred type of music and products, and any sensitivities or allergies that they have. This is the type of personal service that clients value and are willing to pay a premium for. Unfortunately, there is currently no system for storing this type of information so that it can be used by another staff member if the preferred therapist is unavailable or no longer employed at HSS.

Appendix II - Excerpts from the vendor agreement

1. The system comprises four fully integrated modules: a booking module, a billing module, a client management module, and an accounting module. Since the system does not include scheduling or payroll modules, HSS would continue to use its current scheduling program, which would not interface with the new system. The system also does not include a retail inventory management module, as this is not needed in medical offices. It may be something that can be worked on in the future.

2. The billing module is fully integrated with health insurance billing software so that claims are automatically submitted for processing based on insurance information stored in the client management module.

3. The client management module allows for the storage of personal information and treatment preferences and can be customized to include additional fields as needed.

4. The system has very strong controls over the protection of personal data, as they need to meet provincial requirements for storage of medical records.

5. The system has strong access controls, including passwords for individual users and the ability to restrict access to certain modules.

6. The system can be accessed remotely, either over the internet or via a mobile app.

7. The maintenance package includes online and telephone support available from 8 a.m. to 8 p.m. Monday through Friday.

8. The vendor will provide access to online training videos currently available on its website.

9. The system will require new hardware, as HSS's existing hardware does not have sufficient storage or processing capability to run the software.