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: a. A suitable location in a large shopping mall can be rented for $4,200 per month. b. Remodeling and necessary equipment would cost $360,000. The equipment would have a 15-year life and a $24,000 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation. c. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $450,000 per year. Ingredients would cost 20% of sales. d. Operating costs would include $85,000 per year for salaries, $5,000 per year for insurance, and $42,0o00 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 21%, 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.

Particulars	Amount ($)	Amount ($)
Sales		$   450,000.00
Variable expenses:
Cost of ingredients (450,000*20%)	$      90,000.00
Commissions (450,000*15%)	$      67,500.00	$   157,500.00
Contribution margin		$   292,500.00
Fixed Expenses :
Salaries	$      85,000.00
Rent (4,200*12)	$      50,400.00
Depreciation [(360000-24000)/15 years]	$      22,400.00
Insurance	$        5,000.00
Utilities	$      42,000.00	$   204,800.00
Net income		$     87,700.00

2A

Simple rate of Return

24.4%

Simple rate of return = Annual incremental net operating income / Initial investment

=87700/360000=24.4%

2B

2B. Yes, because a simple rate of return is more than 21%.

3A

Payback Period

3.3 years

Payback period = Investment required / Annual net cash inflow

= 360,000 / (87700+22400) = 3.3 years

Annual net cash inflow = Net income + Depreciation

3B. It should not acquired as payback period is more than 3 years.