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 $4,700 per month.
2. Remodeling and necessary equipment would cost $390,000. The equipment would have a 10-year life and a $39,000 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 $500,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $90,000 per year for salaries, $5,500 per year for insurance, and $47,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 14.0% 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 21%, 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:

Contribution format income statement - Paul Swanson
Particulars		Amount
Sales		$500,000.00
Variable costs:
Ingredients	$100,000.00
Commisions	$70,000.00
Total variable costs		$170,000.00
Contribution margin		$330,000.00
Fixed costs:
Rent	$56,400.00
Depreciation	$35,100.00
Salaries	$90,000.00
Insurance	$5,500.00
Utilities	$47,000.00
Total fixed costs		$234,000.00
Net operating income		$96,000.00

Solution 2a:

Simple rate of return = Net operating income / Initial investment =$96,000 / $390,000 = 24.62%

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 = $96,000 + $35,100 = $131,100

Payback period = Initial investment / annual cash inflows = $390,000 / $131,100 = 2.97 years

Solution 3b:

As payback period is higher than 2 year, therefore Swanson should not acquire the franchise.