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 $3,500 per month.
2. Remodeling and necessary equipment would cost $318,000. The equipment would have a 20-year life and a $15,900 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 $380,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $78,000 per year for salaries, $4,300 per year for insurance, and $35,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 11.5% 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 23%, 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.

Sales 380000 Less: Material @20% of sales Salary Insurance Utilities Rent (3500*12) Commission @11.5% of sales Depreciation & amortization Total cost Net operating income each year 76000 78000 4300 35000 42000 43700 15105 294105 85895

2. a.

Investment	318000
Net profit excludig Depreciation & amortisation	101000
Simple rate of return	31.8%

2.b. Since simple rate of return is more than required rate of return of 23%, he can take the franchise.

3 .a.

Investment (A)	318000
Net profit excludig epreciation & amortisation (B)	101000
Pay Back period (A/B)	3.148515
Thus pay back period is 3 years 54 days

3.B. Since pay back period is more than 3 years, he will not acquire the franchise.

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