Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, In
ID: 2539344 • Letter: P
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 54,800 per month. b. Remodeling and necessary equipment would cost 5396,000. The equipment would have a 10-year life and an $39,600 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation. Ingredients would cost 20% of sales. per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., c. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total S510,000 per year d. Operating costs would include $91,000 per year for salaries, S5,600 per year for insurance, and $48,000 of 14.5% of sales. Required: 1. Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet. Place, I Variable expenses Fixed expenses: 2a. 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%.) rate of return 2b. If Mr. Swanson requires a simple rate of return of at least 22%, should he acquire the franchise? O Yes O No 3a. Compute the payback period on the outlet. (Round your answer to 1 decimal place.) years 3b. If Mr. Swanson wants a payback of two years or less, will he acquire the franchise? O Yes O NoExplanation / Answer
1. The income statement would be: Sales $510,000 Variable expenses: Cost of ingredients (20% x $510,000) $102,000 Commissions (14.5% x $510,000) 73,950 175,950 Contribution margin 334,050 Selling and administrative expenses: Salaries 91,000 Rent ($4,800 x 12) 57,600 Depreciation* 35,640 Insurance 5,600 Utilities 48,000 237,840 Net operating income $ 96,210 * $396,000 - $39,600 = $356,400 $356,400 ÷ 10 years = $35,640 per year. 2. The formula for the simple rate of return is: Simple rate of return = Annual incremental net operating income Initial investment = 96210 = 24.30% 396000 Yes, the franchise would be acquired because it promises a rate of return in excess of 22%. 3. The formula for the payback period is: Payback period Investment required Annual net cash inflow = 396000 = 3.00 Years 131850 *Net operating income + Depreciation = Annual net cash inflow $96,210 + $35,640 = $131,850 According to the payback computation, the franchise would not be acquired. The 3 years payback is greater than the maximum 2 years allowed. Payback and simple rate of return can give conflicting signals as in this case.