Question

Problem 13-19 Simple Rate of Return; Payback Period [LO13-1, LO13-6]

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:

A suitable location in a large shopping mall can be rented for $3,000 per month.

Remodeling and necessary equipment would cost $288,000. The equipment would have a 15-year life and a $19,200 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation.

Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $330,000 per year. Ingredients would cost 20% of sales.

Operating costs would include $73,000 per year for salaries, $3,800 per year for insurance, and $30,000 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 17%, 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

1. The operating income calculation is as shown below:

Sales	330000
Cost of Sales	-66000
Gross profit	264000
Depreciation	-17920
Total Operating costs	-106800
Rent	-36000
Commission	-46200
Opreating Income	57080

Total operating costs = 73000+3800+30000 = 106,800Depreciation = (288000-19200)/15 = 17,920

Operating Income =$57,080

2-a. Simple rate of return = 57,080/288000 = 0.1982 = 19.82%

2-b. Yes, he should acquire the franchise since his simple rate of return is 19.81% which is higher than his requirement of 17%

3-a Payback period

Sales	330000
Cost of Sales	-66000
Gross profit	264000
Depreciation	-17920
Total Operating costs	-106800
Rent	-36000
Commission	-46200
Opreating Income	57080
Add back depreciation	17920
Net cash flow	75000

Net cash flow per year = 75,000

For three year, the amount accumuted will be 75000*3 = 225,000

So payback period = 3 + (288000-225000)/75000 = 3+ 0.84 = 3.84 Years

Payback period =3.84 years

3-b Since his requirement is 3 years or less and here we have a payabck of more than 3 years, Swanson will not acquire the frachise