The firm will target all the major films in the US during the period. The heavier would be the purchase price, the chances of getting greater profits increase drastically for the Arundel Group.
Valuing the sequel is the real issue that will be faced by the investment group. Furthermore, construction of the contract needs to be determined. The company will apply the option pricing technique in evaluating the price of the sequence or it can also go with a simple DCF model. The pendulum can swing to anywhere, either the movie can be huge hit or it can bomb on the premier day. In such situation going with purchasing of the right seems to be the best option when the result of the movie is highly volatile.
In the case of options, an assets with high volatility always goes in prefer for the buyer. In such cases, volatility can be of good advantage and principles of the company believe that going for the options suits them better.
If the targeted movie has shown good results at the box office, the company would take the decision of producing the sequel. The sequel could be made by the company or it can take the help of a professional movie-makers to make the sequel for them.
Estimate the per-film value of a portfolio of sequel rights such as Arundel proposes to buy. You may find it helpful to consult the Appendix, which explains how these figures were prepared. What are the primary advantages and disadvantages of the approach you took to valuing rights?
What problems or disagreements would you expect Arundel and a major studio to encounter in the course of a relationship like that described in the case? What contractual terms and provisions should Arundel insist on? Arundel Partners is a financial company with limited experience in the movie industry.
Valuing an original movie is a daunting a task and requires significant expertise on valuing artistic elements. It is due to this reason that many of the movies fail to succeed even when the specialized studios produce them. Therefore, producing a sequel could be a financially viable proposition. Arundel partners probably believe that the price paid to buy a portfolio of sequel rights might allow them to earn a profit if a few of those sequels are actually produced, following the commercial success of the original movie.
The idea is that proceeds generated from the few sequels that are actually produced will outweigh the cost of acquiring a larger portfolio of sequel rights. The partners believe that once the movie goes into production, it might not be advantageous for them to negotiate the sequel rights with the studios.
The reason behind this belief is that once the production starts, the studio will have more information about the movie than Arundel Partners. Such a situation will put the studio at an advantaged position and might lead to an unfair deal for Arundel partners. For instance, the studios might charge a higher price or refuse to sell rights for the films that they later believe to be of higher commercial value.
The profits for Arundel Partners depend on whether the value of the movie sequels is higher than the estimated two million required to buy the rights. There are two main approaches that can be used to forecast the value of the project. The NPV approach uses the cash flows for hypothetical sequels exhibit 7 to calculate the average value of each sequel. The option valuation treats the sequel rights as an option to produce the movie in the future. The NPV approach is simplistic and uses historical data.
Similarly, the option valuation is unrealistic because the assumptions required — constant variance, know volatility, normal distribution — for an option valuation model such as the Black-Sholes model simply do not hold. Designed to introduce students to real options and techniques for valuing them. It clearly illustrates the power of option pricing techniques for certain types of capital budgeting problems.
Also illustrates the practical limitations of such techniques. Brought to you by:. Main Case Classic. Not teaching at a university? Register as a student Register as an individual. Overview Included Materials Related.
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