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:

A suitable location in a large shopping mall can be rented for $5,000 per month.

Remodeling and necessary equipment would cost $408,000. The equipment would have a 20-year life and a $20,400 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 $530,000 per year. Ingredients would cost 20% of sales.

Operating costs would include $93,000 per year for salaries, $5,800 per year for insurance, and $50,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 15.5% 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 18%, 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

Req 1: INCOME STATEMENT
Sales revenue				530000
less: variable expense
Cost of sales (530000*20%)				106000
Sales commission (530000*15.5%)				82150
Contribution Margin				341850
Less: Fixed cost:
Rent (5000*12)				60000
Salaries				93000
Insurance				5800
Depreciation				19380
Utilities				50000
Net Income Earned				113670
Note: Annual depreciation = Cost-salvage value / life of asset
Req 2a: Simple rate of return
Simple rate of return: Net annual income / Initial investment
		(113670 /408000) *100 = 27.86%
Req 2b:
As the target return is 18% and project is giving 27.86% return
Yes, the project must be acquired.
Req 3:
Annual cash flows: Net income + Annual depreciation
		113670+19380 = 133050
Payback period: Initial investment / Annual Cash inflows
	(408000 /133050) = 3.07 years
Req 3b: No franchise shall not be acquired
As thte payback period is mor ethan cut off period of 2 years.