Problem
ProFitness Plc has a chain of gym sites across England, and it is considering expanding. There are two possible locations, Site A and Site B. ProFitness Plc operates on a five-year cycle of investment. Information has been collected on the costs at each site, as well as the population size of the areas where the sites will be. The initial outflow includes the lease of the premises for a five-year period, the costs of redecorating the premises, and the lease costs of the equipment to go in the gym. The net cash inflows for years 1-5 include the monthly gym subscriptions and joining fees, employment costs, and the running costs of the premises. The following table summarises the initial investment required, as well as the net cash inflows for years 1-5.
|
Year
|
Site A
|
Site B
|
|
0
|
(630,000)
|
(540,000)
|
|
1
|
250,000
|
220,000
|
|
2
|
195,000
|
200,000
|
|
3
|
115,000
|
170,000
|
|
4
|
165,000
|
120,000
|
|
5
|
195,000
|
155,000
|
|
Residual value
|
70,000
|
55,000
|
The company's cost of capital is 15%.
I. Calculate the net present value (NPV) and internal rate of return (IRR) of the proposed two sites. You are required to show all your workings to support your answers. The figures should be rounded to two decimal places.
II. Which site should the company invest in? Why?
III. Discuss whether the IRR method is as reliable as the net present value approach as an investment appraisal technique.