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 $3,900 per month.
2. Remodeling and necessary equipment would cost $342,000. The equipment would have a 15-year life and a $22,800 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 $420,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $82,000 per year for salaries, $4,700 per year for insurance, and $39,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 13.5% 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 three years or less, will he acquire the franchise?

Answer 1

Solution 1:
Contribution format income statement - Paul Swanson
Particulars		Amount
Sales		$4,20,000.00
Variable costs:
Ingredients	$84,000.00
Commisions	$56,700.00
Total variable costs		$1,40,700.00
Contribution margin		$2,79,300.00
Fixed costs:
Rent	$46,800.00
Depreciation	$21,280.00
Salaries	$82,000.00
Insurance	$4,700.00
Utilities	$39,000.00
Total fixed costs		$1,93,780.00
Net operating income		$85,520.00

Solution 2a:

Simple rate of return = Net operating income / Initial investment  =$85520 / $342000 = 25.01%

Solution 2b:

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

Solution 3a:

Annual cash inflows = Net operating income  + Depreciation = $85520 + $21280 = $106800

Payback period = Initial investment / annual cash inflows = $342000 / $106800 = 3.20 years

Solution 3b:

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