Franchise Revenue Guarantee Valuation: Real Options Approach

Lukito Adi Nugroho

Graduate School of Advanced Mathematical Sciences, Meiji University, Tokyo, Japan.

DOI: 10.4236/jfrm.2015.41004                

Abstract

In order to survive in the current severe competition, newly established franchises have been looking for new ways to encourage more individuals to become their franchisees. One approach that becoming increasingly widespread is the inclusion of revenue guarantee. This feature attracts risk averse franchisees because it reduces the apparent risk of joining a franchise with the reassurance that they will earn predetermined level amount of income at the early period of the franchise operation. This paper develops analytical framework using real options approach to value revenue guarantee in business format franchise. The model also will be tested using Monte Carlo simulation to assess the impact of the revenue guarantee agreements on franchisee’s present value. Result shows that guarantee is more needed in higher uncertainty environment, but it also comes with a higher cost.

Keywords

Real Options, Franchise, Financial Contract, Monte Carlo Simulation

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1]	Bates, T. (1998). Survival Patterns among Newcomers to Franchising. Journal of Business Venturing, 13, 113-130. http://dx.doi.org/10.1016/S0883-9026(97)00066-9
[2]	Bennigga, S. A., & Czaczkes, B. (2008). Financial Modelling (3rd ed.). Cambridge: MIT Press.
[3]	Blair, R. D., & Lafontaine, F. (2005). The Economics of Franchising. Cambridge: Cambridge University Press. http://dx.doi.org/10.1017/CBO9780511753879
[4]	Chiara, N., Garvin, M. J., & Vecer, J. (2007). Valuing Simple Multiple-Exercise Real Options in Infrastructure Projects. Journal of Infrastructure Systems, 13, 97-104. http://dx.doi.org/10.1061/(ASCE)1076-0342(2007)13:2(97)
[5]	Hull, J. (2010). Options, Futures, and Other Derivatives, 7/e (with CD). India: Pearson Education.
[6]	Jun, J. (2010). Appraisal of Combined Agreements in BOT Project Finance: Focused on Minimum Revenue Guarantee and Revenue Cap Agreements. International Journal of Strategic Property Management, 2, 139-155. http://dx.doi.org/10.3846/ijspm.2010.11
[7]	Kariya, T., & Liu, R. Y. (2002). Asset Pricing Discrete Time Approach. Dordrecht: Kluwer Academic Publishers.
[8]	Kariya, T., Kato, Y., Uchiyama, T., & Suwabe, T. (2005). Tenant Management and Lease Valuation for Retail Properties: A Real Options Approach. International Real Estate Review, 8, 44-82.
[9]	Lee, K. (2010). The Firm’s Value of Franchising and Its Investment Timing and Royalties, a Real Options Approach. International Research Journal of Finance and Economics, 43, 128-138.
[10]	Wibowo, A., & Kochendoerfer, B. (2011). Selecting BOT/PPP Infrastructure Projects for Government Guarantee Portfolio under Conditions of Budget and Risk in the Indonesian Context. Journal of Construction Engineering and Management, 137, 512-522. http://dx.doi.org/10.1061/(ASCE)CO.1943-7862.0000312