Case Write-Up: Arundel Partners
15.415 Finance Theory
Section B, Oysters
Arundel Partners: The Sequel Project
With the purchase of sequel rights, what Arundel is achieving is to have a call option on the revenue that each movie brings. This helps to remove the uncertainty and risks associated with producing a movie, especially with regard to moviegoers’ taste. With the sequel right, Arundel will only exercise this option to produce a sequel if the first movie proved to be popular and the sequel is hence predicted to bring in profits. This provides downside protection, as huge losses (due to high production costs) associated with a failed movie will be avoided.
Arundel plans to agree on the number of films and price per film before either the studio or itself knows which films would be produced. This prevents the studio from increasing the price of the sequel right if it predicts that a particular movie will be a hit. Thus, Arundel is aiming to earn handsome profits from movies that eventually turn out to be a hit, since it would have paid a relatively low price for the call option on the movie. This is an important point as Arundel’s profitability heavily relies on how much it has to pay for the sequel rights. Although most of the movies will not have profitable sequels (hence rendering the option’s payoff as zero), the few hit movies will bring about a huge payoff such that overall, Arundel predicts to profit from this idea.
If we use straight PV analysis of all the movies, by using the PV of Inflow at Yr4 and PV of Negative cost at Yr3, we can calculate the NPV of each movie at Yr0. Since the total NPV for all 6 studios is negative, we will not purchase all the sequel rights if we use this simple NPV analysis. However, MCA Universal and TCFOX have positive NPV’s and hence we are willing to pay up to $4.47M for each sequel of MCA Universal and $6.08M for each sequel of The Walt Disney Company.
| PV Inflow @ T=4
| PV Negative...
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