Reference no: EM13963498

The franchise arrangement between McDonald's and its franchisees is summarized in the following note from McDonald's 2011 annual report.

Conventional franchise arrangements generally include a lease and a license and provide for payment of initial fees, as well as continuing rent and royalties to the Company based upon a percent of sales with minimum rent payments that parallel the Company's underlying leases and escalations (on properties that are leased). Under this arrangement, franchisees are granted the right to operate a restaurant using the McDonald's System and, in most cases, the use of a restaurant facility, generally for a period of 20 years. These franchisees pay related occupancy costs including property taxes, insurance and maintenance. Affiliates and developmental licensees operating under license agreements pay a royalty to the Company based upon a percent of sales, and may pay initial fees.

The results of operations of restaurant businesses purchased and sold in transactions with franchisees were not material either individually or in the aggregate to the consolidated financial statements for periods prior to purchase and sale. Revenues from franchised restaurants consisted of:

Total revenues from franchised restaurants:

Future minimum rent payments due to the Company under existing franchise arrangements are:

In millions Owned                          Leased             Total

Sites                             Sites                                        

2012 1,277.9                         1,147.2             2,425.1            

2013 1,245.7                         1,111.2             2,356.9            

2014 1,207.2                         1,065.3             2,272.5            

2015 1,150.9                         1,005.9             2,156.8            

2016 1,090.5                            964.4             2,036.9            

Thereafter 8,914.2                         7,035.1             15,949.3

Total minimum payments 14,886.4                        12,311.1            27,197.5           

At December 31, 2011, net property and equipment under franchise arrangements totaled $13.8 billion (including land of $4.0 billion) after deducting accumulated depreciation and amortization of $7.1 billion.

From this information, answer the following questions.

1) McDonald's arrangement with its franchisees is that the franchisees agree to pay a minimum rent plus additional amounts if sales are above a certain level. Compare the minimum amount to be received from rent payments in 2012 with the total amount received from franchised and affiliated restaurants in 2011. How significant are these additional amounts?

2) As indicated in the franchise note, McDonald's owns some of its sites and leases others. An important comparison is the relationship between future minimum lease payments McDonald's must make and future minimum payments to be received from franchisees. The future payments (in millions of dollars) McDonald's must make on its leased restaurant sites are summarized as follows.

In millions               Restaurant

2012                       1,172.6

2013                       1,104.8

2014                       1,019.5

2015                       921.9

2016                       813.9

Thereafter               6,039.1

Total minimum payments = $11,071.8

Comparing the payments to be made for leased sites and the minimum payments (plus the additional percentage from royalties) to be collected from franchisees for leased sites, it looks as if McDonald's is guaranteed to make money every year on its leased sites. What would have to happen for McDonald's to lose money on these leased sites?