Question

Confused on this one. Help?

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 $3,700 per month. b. Remodeling and necessary equipment would cost $330,000. The equipment would have a 20-year life and a $16,500 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 $400,000 per year. Ingredients would cost 20% of sales. d. Operating costs would include $80,000 per year for salaries, $4,500 per year for insurance, and $37,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 12.5% 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 20%, 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

Required 1
Expected net operating income each year	Calculations	Yearly Amount
Revenue			$    4,00,000.00
Less: Variable costs
Ingredients 20% of sales	400000*20%	$   80,000.00
Commissions	400000*12.5%	$   50,000.00	$     1,30,000.00
Contribution Margin			$ 2,70,000.00
Less: Fixed Costs
Rent	3700*12	$ 44,400.00
Depreciation	(330000-16500)/20	$    15,675.00
Salaries		$   80,000.00
Insurance		$     4,500.00
Utilities		$   37,000.00	$      1,81,575.00
Net Income			$ 88,425.00
Required 2 (a)
Simple rate of Retun=	Incremental accounting income/Initial investment
=	88425/330000	27%
Required 2 (b)
Since simple rate of return is 27% which is higher than the expected return i.e. 20%, therefore he should acqure the franchise.
Required 3 (a)
Payback period
Step 1 Computation of net annual cash inflow =	Net income + Depreciation =		88425+15675
			$      1,04,100.00
Step 2: Computation of investment: =	330000
Step 3: Computation of payback period:=	Investment required for the project/Net annual cash inflow=		330000/104100
			3.17
			Years
Required 3 (b)
If Mr.Swanson expects a payback period of three years or less, then he should not go with this franchise because the payback period of this is 3.17 years which is more than 3 years.