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 $4,500 per month.
2. Remodeling and necessary equipment would cost $378,000. The equipment would have a 10-year life and a $37,800 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 $480,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $88,000 per year for salaries, $5,300 per year for insurance, and $45,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 13.0% 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

1
The Yogurt Place Inc.
Contribution Format Income Statement
Sales		480000
Variable expenses:
Cost of ingredients	96000		=480000*20%
Commissions	62400		=480000*13%
		158400
Contribution margin		321600
Selling and administrative expenses:
Salaries	88000
Rent	54000		=4500*12
Depreciation	34020		=(378000-37800)/10
Insurance	5300
Utilities	45000
		226320
Net operating income		95280
2a
Net operating income	95280
Divide by Initial Investment	378000
Simple rate of return	25.2%
2b
Yes, as simple rate of return exceeds 19%
3a
Initial Investment	378000
/ Annual cash flows	129300		=95280+34020
Payback period	2.9	years
3b
No, as payback period is more than 2 years.