Question

Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, Inc., to dispense frozen yogurt products under The Yogurt Place name. Mr. Swanson has assembled the following information relating to the franchise:

1. A suitable location in a large shopping mall can be rented for $4,700 per month.
2. Remodeling and necessary equipment would cost $390,000. The equipment would have a 10-year life and a $39,000 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation.
3. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $500,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $90,000 per year for salaries, $5,500 per year for insurance, and $47,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 14.0% of sales.

Required:

1. Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet.

2-a. Compute the simple rate of return promised by the outlet.

2-b. If Mr. Swanson requires a simple rate of return of at least 21%, should he acquire the franchise?

3-a. Compute the payback period on the outlet.

3-b. If Mr. Swanson wants a payback of two years or less, will he acquire the franchise?

Answer 1

1)

PAUL SWANSON
Contribution Format Income Statement
Sales		$ 500,000.00
Variable Expense
cost of ingredients	$ 100,000.00
Commissions	$    70,000.00	$ 170,000.00
Contribution Margin		$ 330,000.00
Selling and Administrative Expense
Salaries	$    90,000.00
Rent	$    56,400.00
Depreciation	$    35,100.00
Insurance	$      5,500.00
Utilities	$    47,000.00	$ 234,000.00
Net Operating Income		$    96,000.00

2a)Simple rate of return = Annual incremental net operating income/Initial Investment

=96,000/390,000

25%

2b)Yes, the franchise would be acquired because it promises a rate of return in excess of 21%

3a)Payback period = Initial investment/Annual Net Cash Inflow

=390,000/(96,000+35,100)

=2.97 Years

3b)According to the payback computation, the franchise would not be acquired. The 2.97 years payback is greater than the maximum 2 years allowed.