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 $3,200 per month.
2. Remodeling and necessary equipment would cost $300,000. The equipment would have a 20-year life and a $15,000 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 $350,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $75,000 per year for salaries, $4,000 per year for insurance, and $32,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 15.0% 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 19%, 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

1.
Contribution format income statement
Sales		$350,000
Variable expenses
Cost of ingredients	$70,000		350000*20%
Commissions	$52,500	$122,500	350000*15%
Contribution margin		$227,500
Selling and administrative expenses:
Rent	$38,400		3200*12
Salaries	$75,000
Insurance	$4,000
Utilities	$32,000
Depreciation	$14,250	$163,650
Net operating income		$63,850
Straight line depreciation = (300000-15000)/20	14250
2.a
Simple rate of return = 63850/300000	21.28%
2.b
Yes, swanson should acquire the franchise as the simple rate of return of franchise is higher than 19%.
3.a
Payback period = Intial investment/Annual cash inflow
Payback period	300000/(63850+14250)
Payback period	3.84	yrs
3b.
No Swanson will not acquire the franchise if payback period required is 3 or less as currently the payback period is 3.84 years which is more than the required payback period