Question

Problem 7-19 (Algo) Simple Rate of Return; Payback Period [LO7-1, LO7-6]

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 $4,300 per month.
2. Remodeling and necessary equipment would cost $366,000. The equipment would have a 20-year life and a $18,300 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 $460,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $86,000 per year for salaries, $5,100 per year for insurance, and $43,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 12.0% 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 22%, should he acquire the franchise?

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

3-b. If Mr. Swanson wants a payback of two years or less, will he acquire the franchise?

Complete this question by entering your answers in the tabs below. Req 1 Req 2A Req 2B Req ЗА Req 3B Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet. The Yogurt Place, Inc., Contribution Format Income Statement Variable expenses: Fixed expenses: < Req1 Req 2A >

Answer 1

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Part 1
Sales		$     460,000
Less: Variable Expense
Cost of ingredients (20% × $460,000)	$      92,000
Commissions (12% × $460,000)	$      55,200	$   (147,200)
Contribution margin		$     312,800
Less: Fixed Expenses:
Salaries	$      86,000
Rent ($4,300 × 12)	$      51,600
Depreciation ($366,000-$18,300)/20	$      17,385
Insurance	$        5,100
Utilities	$      43,000	$   (203,085)
Net operating income		$     109,715
Part 2a
Annual Net Operating Income	a	$     109,715
Initial Investment	b	$     366,000
Simple rate of return	a/b	29.98%
Part 2b
Yes, since return is more than required return.
Part 3a
Annual Net Operating Income		$     109,715
Add: Depreciation		$       17,385
Annula Net cash inflow	a	$     127,100
Initial Investment	b	$     366,000
Payback Period	b/a	2.88	Years
Part 3b
No since payback is more than required