Arundel Partners: The Sequel Project

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Table of Contents
Introduction2
Question 12
Part 12
Part 23
Question 23
Method 1 – Using an Option Pricing Model3
Method 2 – Using the Projected Financial Performances5
Comparison6
Question 37
Advantages7
1.Time Value7
2.Capture Value of Options7
Disadvantages7
1.Assumptions Made7
2.Tax Effect7
3.Historical Data8
4.Selection Bias8
Further Assistance/Data Required8
Question 49
Problems/Disagreement9
Contractual Terms and Provisions9
Appendix A – Per Film Value Using Financial Projections11

Introduction
In 1992, Paul Kagan Associates, Inc. came out with a new business idea. The idea was to create an investment group, Arundel Partners, to purchase the sequel rights associated with films produced by one or more major U.S. movie studios. As owner the rights, Arundel would wait to see if a movie was successful, and then decide whether or not to produce a second film based on the story or characters of the first. One of the unique features of the new idea was that Arundel would purchase sequel rights before the first films were even made and released. Another feature was that the investor group would not make artistic judgements or attempt to select the rights for particular movies based on predictions of a possible sequel’s success. Lastly, Arundel’s advance cash payments for the rights, at an agreed-upon price per film, would help finance production of the initial films. Whether Arundel could expect to make money depended heavily on how much it had to pay to purchase a portfolio of sequel rights. Hence, to ensure that the new business idea would be profitable, the company appointed Mr. David A. Davis, a movie industry analyst to value the sequel rights using the proprietary data on industry cash flows that the company has gathered. Question 1

Part 1
Arundel Partners will be interested in buying movie sequel rights as it enables them to defer the investment without losing the opportunity of profiting from the sequel. They are able to exercise its rights to produce a sequel if the first film is successful enough. Alternatively, Arundel is able to sell the rights to the highest bidder if it does not want to produce the film and could still gain a profit from it. Furthermore, given the database that Arundel has of the results of the sequels of past movies, it is very possible that Arundel is able to make money by producing sequels despite the higher negative costs and lower revenue expected, if the first movie is successful enough. Part 2

Arundel Partners would prefer to purchase a portfolio of rights in advance as it suffers from information asymmetry. The studios would have a better idea of how successful each film would turn out to be once they started production. Furthermore, the studios may be more reluctant to negotiate with Arundel for the rights of sequels once they start production as they may deem the project to be profitable and rather keep it for themselves.  Most importantly, by purchasing in advance, Arundel is able to offer cash when studios need them the most and hence making the deal more appealing to studios. A portfolio of rights would reduce the riskiness compared to individual films as the purchase of sequel rights would be done before the first films were even made. By purchasing a portfolio of rights, Arundel will be able to choose which sequel to produce from the portfolio that is profitable enough and sell or let go of the other sequels which may not be deemed economical to produce after the first film’s release. Question 2

We used two different methods to calculate the per-film value of a portfolio of sequel rights. Method 1 – Using an Option Pricing Model
To estimate the per-film value of a portfolio of sequel rights, we can employ a real option pricing method. The first step in this technique is to recognize the option and describe it. In Arundel’s case, the option is the right (but not the obligation) to develop the...
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