Option and Major Studios

FIN 4414 – Financial Management – Spring 2009 “Arundel” Case Assignment Due: March 23, 2009 Case: “Arundel Partners: The Sequel Project,” HBS, Case # 9-292-140, Revised 12/92. Main Question: Is $2million per movie a fair price? Why or why not? Additional Questions 1. Provide a brief overview of the proposed venture. Clearly describe the relevant time line. 2. Why do the proponents of this venture believe that Arundel Partners can make money buying movie sequel rights? Why do they propose buying a portfolio of rights rather than negotiating the purchase price on a film-by-film basis?

Why do they propose to purchase the sequel rights at t=0 (before the first film is released) rather than at t=1? 3. Assuming a discount rate of 12% (risk free rate of 6% and a risk premium of 6%) calculate the NPV for all the sequels. Use the expected negative costs and the expected revenues given in Table 7. 4. Using the “decision-tree” approach, calculate the per-movie value of the sequel rights to the entire portfolio of 99 movies released in 1989 by the six major studios. . Assume that a maximum of ten sequels can be made in any given year. Using the same decision-tree approach, what would you estimate to be the per-movie value of the sequel rights to the entire portfolio of 99 movies released in 1989 by the six major studios? 6. Using the Black-Scholes approach, calculate the per-movie value of the sequel rights to the entire portfolio of 99 movies released in 1989 by the six major studios. Assume once again that there is no maximum to the number of sequels that can be made in a given year). You must provide details of how you estimated the inputs to the B-S formula. a. Asset value b. Exercise price c. Volatility of asset returns d. Time to maturity e. Risk-free rate HINT: Note that the time to maturity of the options is when uncertainty is resolved not necessarily when the sequel is made. The asset value is what you will get if you exercised the option to make the sequel.

Again use average values for all the sequels. Similarly use the average value of the cost to make the sequels for the exercise price. Estimating standard deviation is a little trickier. Note that you do not have past information on returns to each sequel to estimate volatility for a sequel. However, you have information on a portfolio of sequels and you know the returns to these sequels and you could use these to estimate a standard deviation based on a cross-section of returns (DO NOT USE PRICE LEVELS).

Also the standard deviation should be based on all 99 sequels – that is it should be based on the entire distribution. 7. Carry out a sensitivity analysis of the value of the option to the values of the underlying asset, exercise price, and volatility. 8. What problems or disagreements would you expect Arundel and a major studio to encounter in the course of a relationship like the one described in the case? What contractual terms and provisions should Arundel insist on?

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