deciphering financial statements mcdonald rsquo s corporation the franchise arrangem 692705

Deciphering Financial Statements (McDonald’s Corporation)

The franchise arrangement between McDonald’s and its franchisees is summarized in the following note from McDonald’s 2004 annual report.

Individual franchise arrangements generally include a lease and a license and provide for payment of initial fees as well as continuing rent and service fees 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). McDonald’s 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. Franchisees pay related occupancy costs including property taxes, insurance and maintenance. In addition, franchisees outside the U.S. generally pay a refundable, non interest bearing security deposit. Foreign affiliates and developmental licensees pay a royalty to the company based on percent of sales. The results of operations of restaurant businesses purchased and sold in transactions with franchisees, affiliates and others were not material to the consolidated financial statements for periods prior to purchase and sale. Revenues from franchised and affiliated restaurants consisted of:

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

Instructions: 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 2005 with the total amount received from franchised and affiliated restaurants in 2004.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.

Comparing the payments to be made for leased sites and the minimum payments (plus percent rent) to be collected from franchisees for leased sites, it looks as if McDonald’s is almost 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?