1. Why do the principals of Arundel Partners think they can make money buying movie sequel rights? Why do the partners want to buy a portfolio of rights in advance rather than negotiating movie-by-movie to buy them?
• The principals of Arundel Partners think they can make money buying movie sequel rights because they can use unpredictability of a movie’s success to their advantage. This can be done by exercising the right if the movie is a success or selling rights to another bidder in the event of the movie’s failure. By doing this, they limit the losses on bad sequels to the option price, and maximize the profits on winning movies. This works well since the majority of sequels are losers with winners being large profit gains.
• The partners want to buy a portfolio of rights in advance rather than negotiating movie-by-movie as they know less information about movies than studios do. Additionally, if the movie is a success, the studio would have higher bargaining power and be hesitant to give Arundel Partners the right to produce sequels.
2. Estimate the per-movie value of a portfolio of sequel rights such as Arundel proposes to buy. Use both a discounted cash flow (DCF) approach and an option valuation approach (such as Black-Scholes).
• Per movie value of a portfolio of sequel rights by:
o DCF approach = $4.88 M
We obtained $4.88M through the DCF approach (Exhibit 1) by a taking a summation of all positive NPV sequels and dividing it by the total number of sequel rights available i.e. 99.
Originally, by taking an average of all sequel rights available, we obtained a negative NPV value of $2.4M. Although this value gives us an estimate of the average project value, assigning equal weighting to successful movies as well as failures, does not seem plausible. Since there is significant volatility for the movie business, which DCF cannot account...