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) Income statement
sales		350000
less: variable expenses
cost of intigredient (350000*20%)	70000
commission (350000*15%)	52500	122500
contribution margin		227500
selling & administrative expenses
rent (3200*12)	38400
salaries	75000
insurance	4000
utilities	32000
depreciation (300000-15000)/20	14250	163650
net operating income		63850

2) Simple rate of return = net operating income/cost

simple rate of return = 63850/300000 = 21.28%

3) yes greater than 19%

3a) payback period = investment required/annual cash inflow
cash inflow = net operating income+depreciation
cash inflow = 63850+14250 = 78100
payback period = 300000/78100 = 3.84 years

3b) no greater than 3 years