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 $5,200 per month.
2. Remodeling and necessary equipment would cost $420,000. The equipment would have a 20-year life and a $21,000 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 $550,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $95,000 per year for salaries, $6,000 per year for insurance, and $52,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 16.5% of sales.

Required:

2-a. Compute the simple rate of return promised by the outlet.

3-a. Compute the payback period on the outlet.

Answer 1

SOLUTION

Calculation of net income -

Particulars	Amount ($)	Amount ($)
Sales		550,000
Variable expenses:
Cost of ingredients (20%* 550,000)	110,000
Commissions (16.5%*550,000)	90,750	200,750
Contribution Margin		349,250
Selling and administrative expenses:
Salaries	95,000
Depreciation(420,000-21,000)/20	19,950
Insurance	6,000
Utilities	52,000
Rent (5,200*12)	62,400	235,350
Net Operating Income		113,900

2a. Rate of return = Net Operating Income / Initial investment

= $113,900 / $420,000 = 27.1%

3a. Payback period = Initial Investment/ Annual net cash flow

= $420,000 / 133,850 = 3.14 years

Annual net cash flow = Net Operating Income + Depreciation

= $113,900+19,950 = $133,850