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 $5,100 per month.
2. Remodeling and necessary equipment would cost $414,000. The equipment would have a 15-year life and a $27,600 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 $540,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $94,000 per year for salaries, $5,900 per year for insurance, and $51,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 16.0% of sales.

Required

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

	The Yogurt Place, Inc., Contribution Format Income Statement Variable expenses: 0 0 Fixed expenses: 0 0

2-a. Compute the simple rate of return promised by the outlet.

Simple rate of return

2-b. If Mr. Swanson requires a simple rate of return of at least 19%, should he acquire the franchise?

If Mr. Swanson requires a simple rate of return of at least 19%, should he acquire the franchise?

3-a. Compute the payback period on the outlet.

Payback period

years

3-b. If Mr. Swanson wants a payback of two years or less, will he acquire the franchise?

Answer 1

Answer-1:

Answer-2(a):

Simple rate of return = Annual incremental net operating income / Initial investment = $107,740 / $414,000 = 26.02%

Answer-2(b):

If Mr. Swanson requires a simple rate of return of at least 19%, he should acquire the franchise because his expected rate of return as computed in 2(a) is more than 19% (i.e. 26.02%)

Answer-3(a):

Payback period = Investment required / Annual net cash inflow

= $414,000 / ($107,740 + 25,760)

= $414,000 / $133,500 = 3.10 years

Answer-3(b):

If Mr. Swanson wants a payback of two years or less, he should not acquire the franchise as the calculated payback period is more than 2 years (i.e. 3.10 years)