Franchise Revenue Guarantee Valuation: Real Options Approach

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.