Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, Inc

Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, Inc., to sell frozen yogurt products under The Yogurt Place name. Mr. Swanson has assembled the following information relating to the franchise business.

1) A suitable location in a large shopping centre can be rented for $3,500 per month.

2) Remodelling and necessary equipment would cost $270,000. The equipment would have an estimated 15-year life and an estimated $18,000 salvage value. Straight-line depreciation would be used.

3) Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $300,000 per year. Ingredients would cost 20% of sales.

4) 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 commission to The Yogurt Place, Inc., of 12.5% of sales. Rather than obtain the franchise, Mr. Swanson could invest his funds in long-term corporate bonds that would yield a 12% annual return.

Required:

a) Prepare an income statement that shows the expected net income per year from the business using the contribution margin format.

b) Compute the simple rate of return promised by the outlet. If Mr. Swanson requires a simple rate of return of at least 12%, should he obtain the franchise?

c) Compute the payback period on the outlet. If Mr. Swanson wants a payback of 4 years or less, should the outlet be opened?

d) Calculate the break-even point in dollars for the business. e) Calculate the margin of safety in dollars and the margin of safety percentage.

f) Assume that you calculated the margin of safety percentage in e) to be X%:

- What would happen if company’s sales decreased by X+5 %.

- What would happen if company’s sales decreased by X %.