Question 3 (40 marks) Yellowstone Fitness Club provides sports and physical fitness to the public. It plans to invest in a new sports equipment, Model X, to attract more potential members to join the club. The cost of this sports equipment is $1.5 million and has an economic life of 5 years. It is expected to produce net annual cash receipts of $500,000 at Years 1 and 2: 5400,000 from Years 3 to 5. The scrap value at the end of its economic life is expected to be $50,000. One of the directors has proposed considering inexpensive sports equipment, Model Y, which costs only 80% of Model X. It is expected that the organization can eam an annual profit of S137,000 at the end of each year for the estimated useful life of 5 years for this equipment. Model Y will have a scrap value of $60,000 at the end of its useful life. The organization may rent comparable sports equipment, Model Z, from the sports equipment manufacturer. However, it needs to pay an upfront alliance fee of S1,150,000 to the equipment manufacturer, which lasts for five years. Yet, the manufacturer limits the annual usage rate for the rental sports equipment to 5,000 times. The organization has confidence that its members will use the sports equipment to the limitation imposed by the manufacturer. Also, the organization can charge its members $90 for each use of this equipment. To maintain the equipment functions, the organization can contract with a local maintenance company for servicing. The monthly maintenance charge is expected to be $8,000. However, the maintenance company can offer a 5% discount if the organization signs the maintenance contract for five years. This special offer allows the organization to make annual payments by the end of each year. This special offer will be accepted if the rental option is chosen The cost of capital for the organization is 11% per annum. The organization uses the straight- line method to account for the depreciation of equipment Required: (All working should be rounded to 4 decimal places, and all answers should be rounded to 2 decimal places, if applicable.) (a) Advise if Yellowstone Fitness Club should purchase Model X based on the net present value method. (4 marks) (b) Determine whether Yellowstone Fitness Club should purchase Model X or Model Y based on the net present value method. (8 marks) (c) Based on the payback period method, advise which model should be purchased by Yellowstone Fitness Club. (5 marks) Determine the IRR for Model X and Model Y using the MS Excel built-in function. (2 marks) Determine the IRR for Model Z using the calculation method and checking it by the MS Excel built-in function. Advise which sports equipment model (X, Y, or Z) Yellowstone Fitness Club should choose based on the IRR method. (15 marks) (1) Advise Yellowstone Fitness Club which method discussed above is more appropriate for decision-making on capital budgeting and state the advantages of that method. (6 marks) (d)
