Why This is an Attractive Project
The Arundel Partners' believe that they can make money on this project as it allows them to capitalize on the idiosyncratic risk of the motion picture business. Producing and distributing motion picture films is a risky business due to the uncertainty of moviegoers' tastes and a studio never knows if they have a blockbuster on their hands until after the movie has started production or even later after it has been released. The financial resources of even the largest studios often become strained. Arundel's value proposition, to purchase the rights to movie sequels in a sequence of payments during the producing of the first movie, is to provide funds to the movie studios when they most need it. Arundel benefits from this arrangement as the greatest risk is taken by the movie studios when they produce the original film. Almost all sequels follow successful films and in the last 10-20 years it has become common for successful films to spawn one or more sequels. Arundel will be able to determine the success of the first movie before they decide if they would like to make the sequel so there is a limited down side as they can always choose not to produce a sequel if the first movie performance is poor. In addition, Arundel also has the option to sell the sequel rights to the highest bidder if they do not want to produce the sequel themselves
Why Purchase Movie Rights in Advance
If Arundel Partners' do not negotiate the rights in advance they will find themselves in a position which requires the sequential resolution of uncertainty, successive negotiations of contracts, and a position where each round of negotiations carries the risk of terminating the relationship. The approach that helps Arundel take care of these issues with the studios is that they negotiate the terms and conditions of buying the sequel rights before even the first movie is made. Additionally Arundel can take care of the following issues:
Once the production starts the studio inevitably forms an opinion about the movie and Arundel would not want to have to bargain over individual projects about which it knew less than the studio. This not only undermines Arundel's bargaining position but also increases the transaction cost.
Since the upside potential from a successful sequel is unlimited (with limited downside), Arundel can take maximum benefit of it only by paying an average price across the sequel rights. This is possible only if studios have no opinion formed about the movie or its sequels.
By getting into a deal with studios when their need for finances is the most can earn Arundel Partners not only good deals but also goodwill.
Assumptions of our DCF Analysis and Black-Scholes Model
Applying the DCF method to the hypothetical sequel cash flows provided, we calculated a per-movie value of $4.96M. This was calculated using a discount rate of 12%. The PV of Net inflows were discounted back 4 years and the PV of Negative Costs were discounted back 3 years. The movie value of the positive NPV sequels ($490.87M for 26 movies) was then divided by the total 99 movies in the sample. Detail of our DCF calculation is provided in Exhibit 1. Assumptions and table for the Black-Scholes model can be viewed in Exhibit 2. Exhibit 3 provides a comparison of the two methods broken down by movie studio. The advantages and disadvantages of the two methods are detailed below.
Advantages/Disadvantage of the Two Models
Advantages of the DCF Model
Easy to understand. The DCF model requires few variables, which are easy to apply and understand in the real world.
DCF indicates the intrinsic value of a project rather than the pure comparison between different projects by using the ratios like ROI.
DCF works well when evaluating mutually exclusive projects.
Disadvantages of DCF model
The changes in future cash flows will result in volatile outputs.
Forecasting cash flows more than a few years into the...
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