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 $5,100 per month.
2. Remodeling and necessary equipment would cost $414,000. The equipment would have a 15-year life and a $27,600 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 $540,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $94,000 per year for salaries, $5,900 per year for insurance, and $51,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 16.0% 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 19%, 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

Contrubution Format - Income Statement
Sales		5,40,000
Variable expenses:
Cost of ingredients (20%* 540000)	1,08,000
Commissions (16%*540000)	86,400	1,94,400
Contribution Margin		3,45,600
Selling and administrative expenses
Salaries	94,000
Depreciation(414000-27600)/15	25,760
Insurance	5,900
Utilities	51,000
Rent (5100*12)	61,200	2,37,860
Net Operating Income		1,07,740

2A) Computation of Simple rate of return:

Rate = Net Operating Income I/Initial Investment

= 107740/414000 = 26.02%

2B) He should take the franchise because Simple rate of return is 26.02% which is higher than expected return .

3A) Computation of Paback period

Annual net cash flow = 107740 +25760 = $133500

Payback period = Initial Investment/ Annual net cash flow

= 414000/133500 = 3.10 years

3B) He will not acquire the franchise because payback period is 3.10 Year which is higher that expected payback perod