Arundel Partners Case Study
BACKGROUND & PROPOSAL
In April of 1992, a movie industry analyst name Mr. David Davis of Paul Kegan Associates, Inc. was approached with an interesting and fresh business idea. The proposal was to create a new investment group, Arundel Partners, that would exist solely for the purpose of purchasing sequel rights to motion pictures produced by major U.S. movie studios. The proposal was unusual in that studios rarely sold rights to sequels prior to 1992, and interesting in the sense that it did not target specific movies or negotiate prices based on performance of the first movie. Instead, Arundel wanted to create a portfolio of options to produce all sequels at a studio for a given time period. The incentive to the studios is that Arundel …show more content…
We found these values by taking the Present Value of the negative cost incurred and then adding the PV of the inflows the next year divided by the discount rate, which was given to us as 12%. Once NPVs were found for each individual sequel, we took the sum and divided it by the number of sequels, which is 99. This calculation led us to an NPV of -$3.38. Then we had to discount these values back 2 years to get an average NPV per sequel of -$2.69. We need to discount back 2 years because the NPV for our years 3 and 4 (for the film sequel) give us years 2 and 3, but we want years 0 and 1, so we need to discount again. This is also the year when Arundel would make the purchase. With a negative NPV, it would not make sense for Arundel to purchase sequel rights. Of course this calculation method doesn’t account for the fact that Arundel would in reality only take on sequel production in cases where the original was successful enough to warrant it; it simply assumes that we would take on all projects, when we already know that statistically speaking, the majority of movies are not popular enough to create a successful sequel from. We need a way to model this, and eliminate superfluous negative cash flows from our evaluation. This is where a decision tree method is …show more content…
This number represents the value of this call option, expressed as a percentage of the assets being acquired (average cost of sequel production). In other words, we’d should be willing to pay a total of [$17.22 * 0.451] or $7.77 for the option. These calculations are found in Exhibit C.
We then conducted a sensitivity analysis on our Black-Scholes data, based on changes in Asset value, Exercise Price, and volatility. We chose an asset value range of 10 to 25 (approximately surrounding $17.22 calculated value), and as expected, concluded that as asset value increased, the Black-Scholes % values (option value) increased. Conversely, we found that as exercise price increased, using the same range, the value decreased. Using a volatility range of .5 to 2, we found that volatility and option price, like asset value, also have a positive correlation. The sensitivity analyses can be found in Exhibit
In April of 1992, a movie industry analyst name Mr. David Davis of Paul Kegan Associates, Inc. was approached with an interesting and fresh business idea. The proposal was to create a new investment group, Arundel Partners, that would exist solely for the purpose of purchasing sequel rights to motion pictures produced by major U.S. movie studios. The proposal was unusual in that studios rarely sold rights to sequels prior to 1992, and interesting in the sense that it did not target specific movies or negotiate prices based on performance of the first movie. Instead, Arundel wanted to create a portfolio of options to produce all sequels at a studio for a given time period. The incentive to the studios is that Arundel …show more content…
We found these values by taking the Present Value of the negative cost incurred and then adding the PV of the inflows the next year divided by the discount rate, which was given to us as 12%. Once NPVs were found for each individual sequel, we took the sum and divided it by the number of sequels, which is 99. This calculation led us to an NPV of -$3.38. Then we had to discount these values back 2 years to get an average NPV per sequel of -$2.69. We need to discount back 2 years because the NPV for our years 3 and 4 (for the film sequel) give us years 2 and 3, but we want years 0 and 1, so we need to discount again. This is also the year when Arundel would make the purchase. With a negative NPV, it would not make sense for Arundel to purchase sequel rights. Of course this calculation method doesn’t account for the fact that Arundel would in reality only take on sequel production in cases where the original was successful enough to warrant it; it simply assumes that we would take on all projects, when we already know that statistically speaking, the majority of movies are not popular enough to create a successful sequel from. We need a way to model this, and eliminate superfluous negative cash flows from our evaluation. This is where a decision tree method is …show more content…
This number represents the value of this call option, expressed as a percentage of the assets being acquired (average cost of sequel production). In other words, we’d should be willing to pay a total of [$17.22 * 0.451] or $7.77 for the option. These calculations are found in Exhibit C.
We then conducted a sensitivity analysis on our Black-Scholes data, based on changes in Asset value, Exercise Price, and volatility. We chose an asset value range of 10 to 25 (approximately surrounding $17.22 calculated value), and as expected, concluded that as asset value increased, the Black-Scholes % values (option value) increased. Conversely, we found that as exercise price increased, using the same range, the value decreased. Using a volatility range of .5 to 2, we found that volatility and option price, like asset value, also have a positive correlation. The sensitivity analyses can be found in Exhibit