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 $2,800 per month.
2. Remodeling and necessary equipment would cost $276,000. The equipment would have a 20-year life and a $13,800 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 $310,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $71,000 per year for salaries, $3,600 per year for insurance, and $28,000 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:

A. Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet.

B. Compute the simple rate of return promised by the outlet.

C. If Mr. Swanson requires a simple rate of return of at least 15%, should he acquire the franchise?

D. Compute the payback period on the outlet.

E. If Mr. Swanson wants a payback of three years or less, will he acquire the franchise?

Answer 1

Solution A:

Contribution format income statement - Paul Swanson
Particulars		Amount
Sales		$310,000.00
Variable costs:
Ingredients	$62,000.00
Commisions	$40,300.00
Total variable costs		$102,300.00
Contribution margin		$207,700.00
Fixed costs:
Rent	$33,600.00
Depreciation	$13,110.00
Salaries	$71,000.00
Insurance	$3,600.00
Utilities	$28,000.00
Total fixed costs		$149,310.00
Net operating income		$58,390.00

Solution B:

Simple rate of return = Net operating income / Initial investment  =$58,390 / $276,000 = 21.16%

Solution C:

As simple rate of return exceeded the required rate of return, therefore swanson should acquired the franchise

Solution D:

Annual cash inflows = Net operating income  + Depreciation = $58,390 + $13,110 = $71,500

Payback period = Initial investment / annual cash inflows = $276,000 / $71,500 = 3.86 years

Solution E:

As payback period is higher than 3 year, therefore Swanson should not acquire the franchise.