Question

Problem 13-19 Simple Rate of Return; Payback Period [LO13-1, LO13-6] 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 $3,500 per month. Remodeling and necessary equipment would cost $270,000. The equipment would have a 15-year life and an $18,000 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 $300,000 per year. Ingredients would cost 20% of sales. Operating costs would include $70,000 per year for salaries, $3,500 per year for insurance, and $27,000 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 12%, should he acquire the franchise? 3-a. Compute the payback period on the outlet. 3-b. If Mr. Swanson wants a payback of four years or less, will he acquire the franchise?

Answer 1

1. Prepare Contribution Based Income Statement.

Income Statement (Contribution Margin)
The Place Yogurt Inc.
Sales		$300,000
Less: Variable Costs
Component Cost (20% of Sales)	60,000
Commission (12.5% of Sales)	37,500	(97,500)
Contribution		$202,500
Less: Fixed Costs
Rent	3,500
Salaries	70,000
Depreciation	16,800
Insurance	3,500
Utilities	27,000	($120,800)
Net Operating Income		$81,700

2. (a) Compute the Simple Rate of Return promised by outlet.

Simple Rate of Return = (Incremental Income ÷ Initial Investment) × 100

Simple Rate of Return = ($81,700 ÷ $270,000) × 100 = 30.26

Simple Rate of Return = 30.26%

Incremental Operating Income = Sales − Operating Expense

Inc. Opt. Income = 300,000 − (97,500+120,800) = $81,700

Initial Investment in Equipment = $270,000

Depreciation = (Cost - Salvage Value) ÷ Life

Depreciation = (270,000 -18,000) ÷ 15 = $16,800

2 (b) If Mr. Swanson requires a simple rate of return of at least 12%,

should he acquire the franchise?

Answer. Yes, Mr. Swanson should acquire the franchise as expected

Simple Rate of Return (30.26%) is greater than his required simple rate of

return (12%).

3. (a) Compute Payback Period of the outlet.

Answer.

Payback Period = Initial Investment ÷ Annual Cash-flow

PB..P = $270,000 ÷ $81,700 = 3.3 Years

3(b) If Mr. Swanson wants a payback of four year or less, will he acquire the franchise?

Yes, If Mr. Swanson wants a payback of 4 years, definitely he will

acquire the franchise because his initial investment will be recovered

in 3.3 years.

If he wants payback period of less than 3 years, he would not acquire the franchise.