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

Contribution statement

Particular	Amount
Sales	$380000
Less variable costs
Ingredients (20%)	($76000)
Commission (11.5%)	($43700)
Contribution	$260300
Less fixed cost
Rent ($3500*12)	($42000)
Depreciation	($15105)
Operating costs ($78000+$4300+$35000)	($117300)
Net income	$85895

Depreciation

= (Cost - salvage value) / years

= ($318000-15900)/20

= $15105

2

A . Simple rate of return

= $85895/318000*100

= 27.01

B) since this is more than required rate of 23% , he should accept the franchise.

3. Cash flow = net income + depreciation

= $85895+15105

= $101000

Payback period = $318000/101000 = 3.15 years

Since this is more than required payback period of 3 years , he will not acquire franchise.

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