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:
a. A suitable location in a large shopping mall can be rented for $3,800 per month.
b. Remodeling and necessary equipment would cost $336,000. The equipment would have a 20-year life and an $16,800 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 $410,000 per year. Ingredients would cost 20% of sales.
d. Operating costs would include $81,000 per year for salaries, $4,600 per year for insurance, and $38,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 13.0% of sales.

Required:
1. Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet.
2. Compute the simple rate of return promised by the outlet. (Round percentage answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)
3. If Mr. Swanson requires a simple rate of return of at least 21%, should he acquire the franchise?
4. Compute the payback period on the outlet. (Round your answer to 1 decimal place.)
5. If Mr. Swanson wants a payback of three years or less, will he acquire the franchise?

Answer 1

Answer: Step by step explanation

1.Variable expenses:

Cost of ingredients (20% × $410,000) = $82,000

Commissions (13% × $410,000) = $53,300

Fixed expenses:

Rent ($3,800 × 12) = $45,600

Depreciation:

$336,000 - $16,800 = $319,200

$319,200 ÷ 20 years = $15,960 per year.

2. The formula for the simple rate of return is:

Simple rate of return=Annual incremental net operating income initial investment =$41,328= 12.3%$336,000

3. Yes, the franchise would be acquired because it promises a rate of return in excess of 21%.

4. The formula for the payback period is:

Payback period=(Investment required*Annual net cash inflow)

= (4.5 years * $57,288)

=$257,780

Note:

*Net operating income + Depreciation = Annual net cash inflow

$41,328 + $15,960 = $57,288

5. According to the payback computation, the franchise would not be acquired. The 4.5 years payback is greater than the maximum 4 years allowed.