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 $3,600 per month.
2. Remodeling and necessary equipment would cost $324,000. The equipment would have a 15-year life and a $21,600 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 $390,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $79,000 per year for salaries, $4,400 per year for insurance, and $36,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 12.0% 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 24%, 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

Solution 1:

Joe Swanson
Income Statement
Particulars		Amount
Sales revenue		$390,000.00
Variable costs:
Ingredients	$78,000.00
Commission	$46,800.00
Total Variable costs		$124,800.00
Contribution margin		$265,200.00
Fixd costs:
Rent Expense	$43,200.00
Depreciation expense [($324,000 - $21,600)/15)	$20,160.00
Salaries expense	$79,000.00
Insurance	$4,400.00
Utilities expense	$36,000.00
Total fixed costs		$182,760.00
Net Operating income		$82,440.00

Solution 2a:

Simple rate of return = Net operating income / Initial investment = $82,440 / $324,000 = 25.44%

Solution 2b:

As simple rate of return is higher than 24%, therefore Mr. Swanson should acquire the franchise.

Solution 3a:

Annual cash inflows = Net operating income + Depreciation = $82,440 + $20,160 = $102,600

Payback period = Initial investment / Annual cash inflows = $324,000 / $102,600 = 3.16 years

Solution 3b:

As payback period is greater than 3 years, Swanson should not acquire the franchise.