IHOP Corp. franchises breakfast-oriented restaurants throughout North America. The average development costs for a new restaurant were reported by IHOP as follows:

Land ...... $ 667,000

Building ...... 800,000

Equipment ..... 341,000

Site improvements . 185,000

Total ...... $1,993,000

IHOP develops and owns the restaurant properties. IHOP indicates that the franchisee pays an initial franchise fee of $300,000 for a newly developed restaurant. IHOP also receives revenues from the franchisee as follows:

(1) A royalty equal to 4.5% of the restaurant’s sales;

(2) Income from the leasing of the restaurant and related equipment; and

(3) Revenue from the sale of certain proprietary products, primarily pancake mixes.

IHOP reported that franchise operators earned annual revenues averaging $1,500,000 per restaurant. Assume that the net cash flows received by IHOP for lease payments and sale of proprietary products (items 2 and 3 above) average $200,000 per year per restaurant, for 10 years. Assume further that the franchise operator can purchase the property for $700,000 at the end of the lease term.

Determine IHOP’s:

a. Net investment (development cost less initial franchise fee) to develop a restaurant.

b. Net present value for a new restaurant, assuming a 10-year life, no change in annual revenues, and a 12% desired rate of return. Use the present value tables appearing in Exhibits 1 and 2 in this chapter.