1. Executive Summary
“Nobody knows anything”. This famous line coined by William Goldman, a well known
Hollywood screenwriter, simply but honestly sums up the movie industry. Numerous academic studies have tried to gauge the determinants of movie success but have yet failed to deliver a satisfying answer. Ravid A. (1999) for example finds that neither stars nor big budgets contribute to profitability of a movie. This case study investigates the case of buying sequel rights to original movies. These rights can be understood as a real option allowing the holder the flexibility of decision making depending on the success of the original movie.
In 1992 Paul Kagan Associates Inc. appointed Mr. David …show more content…
One could then earn a profit by exercising the right to produce the sequel or leaving it unexercised based on the expected future return of the sequel that would depend on the performance of the original movie. The business strategy incorporated several key insights regarding the movie business: movie returns are hard to predict, production and distribution of movies is risky and there exist conflicts of interest between creative and business considerations. AP believed it was possible to solve these issues by buying a portfolio of rights to movie sequels from production companies before the original movies were produced. Buying such rights upfront with an equal dollar value attached to each film was advantageous to AP but also to production companies. With a portfolio or slate of movies AP essentially spread the risk and kept the potential of having a best-seller. Further, they avoided the problem of asymmetric information due to the fact that as movie projects progressed the production companies would gain an informational edge over AP that would eventually induce higher prices for the sequel rights. And by providing seed capital to the movie producers, AR gained negotiating …show more content…
In our case these are 28 films out of a total sample of 99 films. Then we recognise that the negative costs will be incurred three years ahead, while the revenue (net inflows) will accrue in four years time. Thus, we calculate the discounted value for both the negative cost and the net inflows on a one-film basis by multiplying the corresponding mean values by the fraction of sequels with positive estimated returns over the total sample size (28/99). We obtain a break-even value per sequel right of $6.47 million as of 1988 which is above the minimum required amount of
$2 million that producers would require in order to give up the rights to sequels (see case study). We note that the NPV only considers one year of data, thus a sample with only one observation, which does not allow for reliable inferences. Further, the model neglects the modelling of uncertainty of future cash flows. Since we evaluate all the studios in the same
“package” we disregard the possibility that movie studios may differ with respect to results
(revenue and returns). Thus, a prudent investment decision should be based on a refined analysis that concentrates solely on the studio one wants to do business