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 $4,900 per month.

Remodeling and necessary equipment would cost $402,000. The equipment would have a 20-year life and a $20,100 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 $520,000 per year. Ingredients would cost 20% of sales.

Operating costs would include $92,000 per year for salaries, $5,700 per year for insurance, and $49,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 15.0% 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 20%, 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

Solution:
1.	PAUL SWANSON
	Contribution Format Income Statement
	Sales		$520,000
	Variable expenses:
	Cost of ingredients	$104,000
	Commissions	$78,000
			$182,000
	Contribution margin		$338,000
	Selling and administrative expenses:
	Salaries	$92,000
	Rent	$58,800
	Depreciation	$19,095
	Insurance	$5,700
	Utilities	$49,000
			$224,595
	Net operating income		$113,405
Working Notes:
	PAUL SWANSON
	Contribution Format Income Statement
I	Sales		$520,000
	Variable expenses:
II	Cost of ingredients	$104,000
	[$520,000 x 20% = $104,000    ]
III	Commissions
	[$520,000 x 15% = $78,000    ]	$78,000
IV=II + III			$182,000
A	Contribution margin		$338,000
	Selling and administrative expenses:
V	Salaries	$92,000
VI	Rent	$58,800
	[4,900 x 12 = 58,800 ]
VII	Depreciation	$19,095
	[($402,000-$20,100)/20 = $19,095 ]
VIII	Insurance	$5,700
IX	Utilities	$49,000
X=V+VI+VII+VIII+IX			$224,595
XI=A-X	Net operating income		$113,405
Depreciation	=(cost -salvage value)/life
2.-a.	Simple rate of return	28.21%
Working Notes:
	Simple rate of return = Annual incremental net operating income /Initial investment
	Simple rate of return = $113,405 /$402,000
	Simple rate of return = 0.28210199
	Simple rate of return = 28.21%
2-b.	YES
Notes:	YES, he should acquire the Franchise since its rate of return 28.21% which is excess of 20%
3-a.	Payback period	3.03 years
Working Notes:
	Payback period = Initial investment /Annual net cash inflow
	Initial investment = $402,000
	Annual net cash inflow = Depreciation + Net operating income
	Annual net cash inflow = $19,095+ $113,405
	Annual net cash inflow = $132,500
	Payback period = Initial investment /Annual net cash inflow
	Payback period = $402,000 /$132,500
	Payback period = 3.03396 years
	Payback period = 3.03 years
3-b.	NO
Working Notes:
	Since, the franchise payback period is 3.03 years, but Mr. Swanson wants a payback of two years or less, hence, He should not acquire the franchise.
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