Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, In
ID: 2784803 • 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 suitable location in a large shopping mall can be rented for $4,600 per month.
Remodeling and necessary equipment would cost $384,000. The equipment would have a 10-year life and a $38,400 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 $490,000 per year. Ingredients would cost 20% of sales.
Operating costs would include $89,000 per year for salaries, $5,400 per year for insurance, and $46,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 13.5% 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 20%, 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?
Explanation / Answer
Rent would be 4600 per month thus 4600*12=55200 per year, Also the ingrediants would cost 20% of sales thus COGS = 0.2*490000 = 98000. The commision paid is 13.5 % of sales = 0.135*490000 = 66150
Answer 1. Please see the below spreadsheet for the income statement format for net operating income:
Per Year
Sales
490000
COGS
98000
Gross profit
392000
Salaries
89000
Insurance
5400
Ulitities
46000
Commission
66150
Net Operating Income
185450
Answer 2. a. simple rate of return = net profit / investment
Here assuming zero tax. And the Equipment would cost 384000 with the salvage value of 38400 for 10 years, thus based on SLM the depreciation would be
384000-38400 / 10 = 34560
Thus Operating income - depreciation = net income = 185450 - 34560 = 150890
Hence,
Simple rate of return = 150890 / 384000 = 0.39294 = 39.294%
Answer 2b. as the simple interest rate computed is 39.294% which is greater than required simple rate of return of 20%, The franchise should be acqiuired.
Answer 3. The Payback period of the project is as below:
Year
Cashflow
Cumulative cashflow
0
-384000
-384000
1
150890
-233110
2
150890
-82220
3
150890
68670
4
150890
5
150890
6
150890
7
150890
8
150890
9
150890
10
189290
Formula for payback period used = (150890-68670)/150890 + 2
Payback period (in years)
2.54
Answer 3b. As the projects payback period is 2.54 years, Mr Swanson who wants it to be 2 years or less wont acquire the franchise.
Per Year
Sales
490000
COGS
98000
Gross profit
392000
Salaries
89000
Insurance
5400
Ulitities
46000
Commission
66150
Net Operating Income
185450