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:

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 $4,000 per month.
b.	Remodeling and necessary equipment would cost $348,000. The equipment would have a 20-year life and an $17,400 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 $430,000 per year. Ingredients would cost 20% of sales.
d.	Operating costs would include $83,000 per year for salaries, $4,800 per year for insurance, and $40,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Inc., of 14.0% of sales.

 

Required:

1.

Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet. Explanation: 1. Variable expenses: Cost of ingredients (20% × $430,000) = $86,000 Commissions (14.0% × $430,000) = $60,200   Selling and administrative expenses: Rent ($4,000 × 12) = $48,000   Depreciation: $348,000 – $17,400 = $330,600 $330,600 ÷ 20 years = $16,530 per year.   2a. The formula for the simple rate of return is:   Simple rate of return =  Annual incremental net operating income  Initial investment           = $91,470   = 26.3% $348,000   2b. Yes, the franchise would be acquired because it promises a rate of return in excess of 19%.   3a. The formula for the payback period is:   Payback period = Initial investment Annual net cash inflow           = $40,000   = 3.2 years $108,000*   *Net operating income + Depreciation = Annual net cash inflow $91,470 + $16,530 = $108,000   3b. According to the payback computation, the franchise would not be acquired. The 3.2 years payback is greater than the maximum 3 years allowed. Payback and simple rate of return can give conflicting signals as in this example.