Dana Dubois, Divesh Goyal, James Carwana, John Petry, Sameer Sharma
Assignment #2
Question 1
Why do the principals of the Arundel Partners think that they can make money buying movie sequel rights?
Arundel’s principals viewed pre-purchasing the sequel rights to films as an option, always valuable.
Similar to purchasing a call, their proposal would allow them to set a purchase price based on
predicted returns and volatility and that price would stick. Were they to wait for a film to come out
and hit, there would be a bidding war for the sequel rights, driving it up way beyond their initial
“call” offering. With the rights in hand, they’ve purchased something that could be valuable at a
future time – they can either produce a sequel that could be a success, or the rights could be bought
from them at a higher price after the original film release
What is their strategic advantage?
Arundel was offering studios money up front when they needed it the most – during the production
phase. Considering the risk involved in producing a movie, the chance of success and probability that
a sequel will actually be made, studios didn’t have to wait to get this money. No other company was
offering this.
Question 2
Why do the partners want to buy a portfolio of rights in advance rather than negotiate film-by-film to buy them?
Once a film goes into production, the studio has more information than Arundel over the possible
success and potential for a sequel. They could use that information to drive up the price of certain
films. In essence, Arundel was eliminating the possibility of the studio having insider information.
Question 3
Based on the average film in 1989, if we use a simple NPV approach, what is the expected NPV of owning a
sequel? What is the problem with this and why might we use an option pricing approach instead?
Hypothetical Sequel Averages (millions):
PV of Net Inflows
PV of negative cost
NPV
21.6
(22.6)
-1
The problem with computing the NPV of owning a sequel this way is that it assumes every film has
an equal chance of being made into a sequel with the same revenues and costs – volatility and
expected return vary. The option approach will take into account the varying risk and volatility,
giving us the real value of the project. We’re also not looking for the value of only one film which the
NPV does – we’re looking for the value of a whole portfolio.
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Dana Dubois, Divesh Goyal, James Carwana, John Petry, Sameer Sharma
Question 4
Using a Black-Scholes option-pricing approach, estimate the per-film value of a portfolio of sequel rights such as
Arundel proposes to buy, given the data about the 1989 films in exhibits 6 and 7. (Hint. Consider the value of the
average sequel in 1989 to do this).
Using the Black-Scholes option-pricing approach there are two methods to estimate the perfilm value of a portfolio of sequel rights. The first method is to calculate NPVq and Cvol
then use an Option-Pricing Table. The second method is to use the full Black-Scholes
formula. Although the full Black-Scholes formula will give a more accurate numerical
answer, it is arguably irrelevant because sensitivity analysis should more than cover any
rounding errors introduced by the table. Regardless, we will use the full Black-Scholes
formula for an idealized answer.
Using Exhibit 7 we can directly obtain the average PV of inflows at year 4 and average cost
at year 3.
AVG(S) @ Yr 4
AVG(X) @ Yr 3
21.57
22.64
The inflows must be discounted to year 0 using WACC.
𝐴𝑉𝐺(𝑆) 21.57
𝑆=
=
= 13.7066
(1 + 𝑟)𝑇 1.124
PV(X) should be discounted to year 0 using the Risk-Free rate.
𝐴𝑉𝐺(𝑋)
22.64
𝑃𝑉(𝑋) =
=
= 19.0110
𝑇
(1 + 𝑟𝑓)
1.063
The remaining variables needed by Black-Scholes are defined as follows:
𝑇 = 𝐿𝑒𝑛𝑔𝑡ℎ 𝑜𝑓 𝑇𝑖𝑚𝑒 𝑡𝑜 𝑀𝑎𝑘𝑒 𝐷𝑒𝑐𝑖𝑠𝑖𝑜𝑛 = 3 𝑦𝑒𝑎𝑟𝑠
𝑟𝑓 = 𝑇𝑖𝑚𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑀𝑜𝑛𝑒𝑦 = 6%
𝜎 = 𝑅𝑖𝑠𝑘𝑖𝑛𝑒𝑠𝑠 𝑜𝑓 𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 = 1.21 𝑝𝑒𝑟 𝑎𝑛𝑛𝑢𝑚
𝑆
)
𝑃𝑉(𝑋)
𝑑1 =
+ 0.5 ∗ 𝜎√𝑇 = 0.89180
𝜎√𝑇
𝑑2 = 𝑑1 − 𝜎√𝑇 = −1.20398
ln (
Then…
𝑪𝒂𝒍𝒍 𝑽𝒂𝒍𝒖𝒆 = 𝑆 ∗ 𝑁(𝑑1) − 𝑃𝑉(𝑋) ∗ 𝑁(𝑑2) = 𝟖. 𝟗𝟖𝑴
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Dana Dubois, Divesh Goyal, James Carwana, John Petry, Sameer Sharma
Question 5
Use the following alternative approach to estimate the per-film value of the portfolio: use the data in Exhibits 6 and 7
to construct the average payoff of successful sequels. Based on this, calculate how much Arundel should pay for each
sequel in its portfolio
The table below shows the successful sequels taken from Exhibit 7.
LOOK WHO'S TALKING
DRIVING MISS DAISY
HONEY, I SHRUNK THE KIDS
BATMAN
PARENTHOOD
PET SEMATARY
DEAD POETS SOCIETY
WHEN HARRY MET SALLY
BORN ON THE FOURTH OF JULY
UNCLE BUCK
THE LITTLE MERMAID
TURNER & HOOTCH
DO THE RIGHT THING
FIELD OF DREAMS
MAJOR LEAGUE
STEEL MAGNOLIAS
YOUNG EINSTEIN
THE WAR OF THE ROSES
K-9
WEEKEND AT BERNIE'S
SHOCKER
SEE NO EVIL; HEAR NO EVIL
SEA OF LOVE
THREE FUGITIVES
HARLEM NIGHTS
THE 'BURBS
THE DREAM TEAM
LEAN ON ME
SUM
AVERAGE
PV(Net
Inflows)
@ yr 4
105.5
77.6
111.2
229.1
76.8
41.1
74.4
64.6
56.8
47.0
62.0
54.6
21.2
47.3
33.7
61.7
10.2
63.8
29.3
22.3
12.4
32.0
44.4
29.1
51.1
27.3
22.9
22.9
1532.3
54.73
Hypothetical sequel
PV(Negative
Cost)
@ yr 3
14.1
11.3
31.0
70.5
28.2
15.5
28.2
26.8
25.4
21.2
28.2
25.4
9.9
22.6
16.9
31.0
5.6
35.3
16.9
14.1
8.5
25.4
35.3
24.0
42.3
24.0
21.2
21.2
680.0
24.29
1-year
Return
6.48
5.87
2.59
2.25
1.72
1.65
1.64
1.41
1.24
1.22
1.20
1.15
1.14
1.09
0.99
0.99
0.82
0.81
0.73
0.58
0.46
0.26
0.26
0.21
0.21
0.14
0.08
0.08
37.27
1.33
Based on the above table we extrapolate the following information:
AVG(S) @ Yr 4
AVG(X) @ Yr 3
54.73
24.29
To calculate the per-film value using the alternative approach we need to calculate the profit
at year 3, discount the profit to year 0, then multiply this result by the probability of success.
These steps are shown below:
AVG(S) @ Yr 3
AVG(X) @ Yr 3
NPV Profit @ Yr 3
NPV Profit @ Yr 0
Probability of Success
Per-Film Value
54.73 / 1.12
Taken directly from data
(AVG(S) – AVG(X)) @ Yr 3
24.58 / (1.12^3)
28 films / 99 attempts
17.48 * 28.2828%
48.86
24.29
24.58
17.49
28.2828%
4.95M
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Dana Dubois, Divesh Goyal, James Carwana, John Petry, Sameer Sharma
Therefore, using the alternative approach the per-film value of the portfolio is 4.95M
Question 6
When valuing the films in Exhibits 6 and 7, should all of the films be included? How might you systematically exclude
films if you decide that some should not be considered?
Valuing all the films in the exhibits would only be helpful if a deal were being made with the film
industry in general. BUT, this is not going to happen. Perhaps Arundel should be valuing the films of
each studio separately to decide who they should make a deal with and for how much. They can also
pare it down even more if they want to divide the films into different genres – perhaps action films
are more valuable as sequels, or comedies.
Question 7
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? In light of this, what contractual terms and provisions should Arundel
insist on?
It’s likely that a film studio could get into disagreements with Arundel over multiple situations:
 When they produce a film that they already know will be one of many (Harry Potter,
Twilight) and already have a high following. Studios sometimes already know an existing
audience of properties they buy. If they get into something they already know is going to be
valuable, they may be hesitant to give the rights away.
 If a studio consistently puts out films that succeed after a deal with Arundel, they will see
their development projects and sequel rights as more valuable than they originally thought,
possibly demand more money. The risk has gone down, and return has gone up.
 If a studio firmly believes that a film will have a sequel then it may delay production until
after the Arundel contract expires.
Arundel should consider these potential scenarios and make sure they get as specific as possible for
what films they want in their portfolio. They also need to make sure they cover themselves for the
above possibilities, and set specific terms of who is involved in the projects, what the studio can ask,
and a time period.
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