Putting in an insulated subfloor is definitely the ideal flooring solution, but is not really necessary. I've yet to see anyone actually do it! With your limited clearance, I would just go with carpeting or vinyl for the floor. If you insulate the walls properly, the space will hold heat pretty well. It might not be the best space for toddlers to roll around. The minimum space loss for a suspended ceiling is around 3 inches - you might want to use wallboard for the ceiling.
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