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 3,500 per month. b. Remodeling and necessary equipment would cost 270,000 . The equipment would have a 15 -year life and an 18,000 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 300,000 per year. Ingredients would cost 20% of sales. d. Operating costs would include 70,000 per year for salaries, 3,500 per year for insurance, and 27,000 per year for utilities. In addition, Mr. Swanson would have to pay a commiss2.14ion to The Yogurt Place, Inc., of 12.5% of sales.Required:(Ignore income taxes.)
(c) Compute the payback period on the outlet. If Mr. Swanson wants a payback of four years or less, will he acquire the franchise?

The incremental net income anticipated from a potential investment opportunity, divided by the investment made in it, is the simple rate of return. To decide whether a corporation should invest in a fixed asset and any incremental change in working capital linked with the asset, the simple rate of return is employed in capital budgeting analysis. The project offers a straightforward rate of return of 8% (measured as $8,000 incremental net income / $100,000 investment), for instance, if a company can earn an incremental increase in its net income of $8,000 in exchange for a $100,000 initial investment.

Calculation:

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 upon Initial investment =

$91,470 upon $348,000 = 26.3%
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 upon Annual net cash inflow =

$40,000 upon $108,000*

= 3.2 years

*Net operating income + Depreciation = Annual net cash inflow

$91,470 + $16,530 = $108,000

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