Problem 13-19 Simple Rate of Return; Payback [LO13-1, LO13-6] Paul Swanson has a
ID: 2501933 • Letter: P
Question
Problem 13-19 Simple Rate of Return; Payback [LO13-1, LO13-6]
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:
A suitable location in a large shopping mall can be rented for $3,800 per month.
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.
Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $410,000 per year. Ingredients would cost 20% of sales.
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.
Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet.
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%.)
If Mr. Swanson requires a simple rate of return of at least 21%, should he acquire the franchise?
Compute the payback period on the outlet. (Round your answer to 1 decimal place.)
If Mr. Swanson wants a payback of three years or less, will he acquire the franchise?
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:
Explanation / Answer
Requirement 1:
Projected Income Statement
2a. Simple rate of return is net operating income / sales x 100 = 89,540/410,000 x 100 = 21.8%
2b. Yes.
3a. Depreciation, being non cash expense, is added back to net operating income to arrive at annual cash flows.
Hence annual cash flows are $ 89,540 + $15,960 = $ 105,500
Payback period for an investment is calculated as initial cash outlay / net annual cash flows
In this case therefore, payback period is $ 336,000 / $105,500 is 3.2 years.
3b. No, since the payback period exceeds 3 years.
$ $ Sales 410,000 Less variable ingredient cost 82,000 Less variable commission @ 13% on sales 53,300 (135,300) Contribution margin 274,700 Less other operating costs(fixed) Salaries 81,000 Insurance 4,600 Utilities 38,000 Rent(3,800 x12) 45,600 Depreciation (336,000-16,800) /20 15,960 (185,160) Net operating income 89,540