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 $4,200 per month.
2. Remodeling and necessary equipment would cost $360,000. The equipment would have a 15-year life and a $24,000 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 $450,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $85,000 per year for salaries, $5,000 per year for insurance, and $42,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 15.0% 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 three years or less, will he acquire the franchise?

Answer 1

Contribution format Income Statement
Sales	450,000
Less: Variable costs
Ingredients	90,000
Salaries	85,000
Insurance	5,000
Utilities	42,000
Commission	67,500
Total Variable costs	289,500
Contribution Margin	160,500
Less: Fixed costs
Rent	50,400
Depreciation	22,400
Total Fixed costs	72,800
Net Operating Income	87,700
2-a Simple rate of return = Operating Income/Average Investment
Average Investment = (Cost price+Salvage value)/2
Hence, simple rate of return = 87,700/192,000 = 45.68%
Yes
3-a Payback period = Cost of Equipment/Annual cash flows
=360,000/110,100 = 3.27 years
No