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 $5,100 per month.
2. Remodeling and necessary equipment would cost $414,000. The equipment would have a 15-year life and a $27,600 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 $540,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $94,000 per year for salaries, $5,900 per year for insurance, and $51,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 16.0% 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 two years or less, will he acquire the franchise?

Answer 1

1)
Contribution Margin Income Statement
Sales		540000
Variable expenses:
Ingredients (540,000*20%)	108000
Commissions (540,000*16%)	86400	194400
Contribution Margin		345600
Less: Fixed expenses
Rent (5100*12)	61200
Depreciation (414,000-27600)/15	25760
Insurance	5900
Utilities	51000
Salaries	94000	237860
Net Operating Income		107740

2-a)

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

Simple rate of return = 107,740/414000

Simple rate of return = 26.0%

2-b)

As the simple rate of return computed above is more than the required

rate of return (19%), Mr. S should acquire the franchise

3-a)

Payback period = Initial Investment/ Annual net cash flow

Payback period = 414,000/(107740+25760)

Payback period = 414,000/133500

Payback period = 3.1 years

3-b)

As the payback period computed above is more than the required

payback period of 2 years, Mr. S should not acquire the franchise

Answer 2

1)	The Yogurt Place, Inc
	Contribution format   Income Statement
	Sales Revenue		540,000
	Variable Expenses
	Ingredients	108,000
	Sales  Commission	86,400	194,400
	Contribution margin		345,600
	Fixed Expense:
	Rent	61,200
	Depreciation	25,760		(414000-27600)/15
	Salaries	94,000
	Insurance	5,900
	Utilities	51,000	237,860
	Net Operating Income		107,740
2)-A	Simple Rate of Return = Annual Net   Income/ Initial Investment
	=(107740/414000)
	26.0%
2)-B	Yes
3-A)	payback Period =Initial investment /   Annual net cash flow
	=(414000/133500)
	3.1	Years
3-B)	No
	Note: Annual net cash flow = net   income + depreciation
	=(107740+25760)
	133,500