Draw a decision tree based on the information below.
Preliminary market research shows that there appear to be favorable conditions for your restaurant in other communities in your home state of Iowa as well as in Kansas and Colorado. Because your original restaurant is so busy, you’re concerned about managing multiple locations so you’re considering franchising to facilitate expansion. You consulted with an attorney about franchising agreements and learned that the agreements are simpler (and thus cheaper) if franchisees locate only in Iowa versus locating in other states.
You’re faced with the decision of whether to franchise in Iowa or expand into other states. You’re somewhat uncertain about how successful this effort will be. You estimate that there is a 30 percent chance that demand for franchises will be brisk and a 70 percent chance that demand will be slow.
The attorney fees for a multi-state franchise agreement are $170,000 while a Iowa-only franchise agreement costs $85,000. Profits are generated through franchise fees (which are higher for out-of-state franchises) and royalties (a percentage of gross revenue). The franchise agreements are typically for fifteen years, so the present value of profits over the fifteen year term is presented.
If demand is brisk for new locations outside of Iowa, the estimated present value of resulting profits, (excluding attorney fees) is $4.5 million. If demand is slow for new locations outside of Iowa, the estimated present value of profits (excluding attorney fees) is $3.75 million. If demand is brisk for franchises only in Iowa, the present value of the resulting profits (again, excluding attorney fees) is $4.2 million. If demand is slow for franchises only in Iowa, the present value of the resulting profits (again, excluding attorney fees) is $3 million.
You have one other alternative. This is to franchise only in Iowa, wait to see the market demand, and then, if the situation warrants, have your attorney develop multi-state franchise agreements. The present value of profits would equal that of the multi-state franchise agreement; however it would cost an additional $100,000 to expand the franchise agreement in this manner.