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. A suitable location in a large shopping mall can be rented for $4,400 per month.

b. Remodeling and necessary equipment would cost $372,000. The equipment would have a 10-year life and a $37,200 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation.

c. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $470,000 per year. Ingredients would cost 20% of sales.

d. Operating costs would include $87,000 per year for salaries, $5,200 per year for insurance, and $44,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 12.5% 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

Solution:

Given data:

* Equipment Cost = $3,72,000

*salvage value =$37,200 & 10years life

* sales = $4,70,000

*Ingrediants would be =20% of sales

* salaries = $87,000

*insurance = $5,200

*utilities =444,000

*Commision =12.54% of sales

(1):

(2a) : Computation of Simple Rate of return –

Formula:

Simple rate of Return = Annual increment Net Operating Income / Initial Investment

                                          = $87,700 / $3,72,000

                                          = 23.57%

Therefore Simple rate of Return     = 23.57%

(2b) : yes ,The franchise would be acquired , as it promises a rate of return in excess of 18%

(3a) : Computation of Payback Period :

   Formula:

Pay back period = Investment required / Annual net cash inflow

                               = $3,72,000 / 1,21,250 (Wn)

                              = 3 years

Working Notes:

Computation of Annual net cash Inflow –

Formula:

Annual net cash Inflow = Net Operating income + depreciation

                                            =87,770 + 33,480

                                           = $1,21,250

(3b) : No, The franchise would not be acquired according to Payback period .

                   The 3years payback period is greater than 2 years.