Ken owns and operates a gym. Currently, he has some unused space at the front of his gym as well as a sizeable amount of cash he has saved up. He would like to reinvest this extra cash into his business.

He has come up with the following ideas for improving his gym based on feedback from gym members:

• Increase the online advertising budget to attract more new customers
• Install a kiosk in the unused space to sell healthy snacks and nutritional supplements to members
• Install extra shelving in the storeroom to hold inventory for the prospective kiosk

• Renovate the unused space to deliver online exercise classes.

a) From the information above, identify a pair of projects that are independent, a pair of projects that are mutually exclusive, and a pair of contingent projects. Clearly label your responses. (3 marks)

b) Choose one of Kens ideas above and give an example of how that idea may have unconventional cash flows. (1 mark)

Ken has spoken to a consultant, who has instead recommended either upgrading the existing equipment or an expansion of the gym.

Upgrading the equipment will cost $22,000 immediately, and the projected generated cash flows are $17,000, $12,000, and $9,000 at the end of each of the coming 3 years (the first one occurring exactly 1 year from today), then a maintenance cost of $1,000 exactly 4 years from today. There will be no more cash flows after that.

The expansion will have an initial cost of $160,000 payable immediately. Ken believes there will be no cash flows for the first year. From there, he believes that he will receive $48,000, $42,000, and $36,000 at the end of each of the coming 3 years. Explicitly, the $48,000 will be received exactly 2 years from today. After that, the additional cash flow is assumed to be $22,000 at the end of each year in perpetuity

The cost of capital is 18% per annum effective.

c) Calculate the NPV for upgrading the existing equipment. (1 mark)

d) Calculate the NPV for the expansion. (2 marks)

e) Calculate the payback period (PP) for both projects. (2 marks)

f) You should have found that the expansion has both a higher NPV and a higher PP than the renovation. Give a reason why these two criteria have given conflicting results. (1 mark)