Fin 488 Case Study 3 Arundel PDF

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Arundel Case 3 FIN 488 – Ullrich I.

Executive Summary The valuation of a sequel right’s worth ranges from $4-5.5 million profit per sequel with

multiple possibilities of falling outside that range depending on which sequels Arundel Partners ultimately decide to make. Net Present Value (NPV) analysis poses a valuation of $4.88 million per sequel right barring the fact that Arundel Partners creates only the 26 sequels with positive NPVs out of the 99. Valuation using the Black-Scholes model presents an option price of about $5.36 million using the 1989 movie data. II.

NPV Analysis As stated above, there are 26 potential sequels that pose a profitable NPV after

discounting the hypothetical sequel cash flows back to present day. Even though $4.88 million per sequel right is the highest valuation through NPV analysis, it may be considered unreasonable to assume that Arundel will decide to create all 26 sequels for the films with profitable NPVs. I decided to further subdivide the 26 profitable sequels into categories. As seen in Attachment I in Appendix A, breaking the films up into genres or by studios diminishes the original $4.88 million valuation. For example, the studio with the highest total NPV was the Walt Disney Company with five profitable films. If Arundel decides to only make the profitable Disney sequels, the profit per sequel right goes down to $1.13 million. In general, profit per sequel decreases the less films you make. If Arundel decides to create the top 15 profitable sequels, the profit per sequel is $4.48 million. This number goes down to $3.73 million and $2.70 million for the top ten and top five sequel categories respectively. Out of the 26 profitable sequels, 15 were comedy films. If Arundel makes all of the

profitable comedy films the profit per sequel is $2.23 million. This could be a potential option if Arundel knows a film studio that specializes in comedic cinema that they can resell the rights to. During negotiation talks, I would strongly suggest to bring up the alternative of buying the 99 films excluding the biographies. Biographies almost always never have a sequel and there are four of them that would be included in the original purchase of sequel rights. Even with th

Born on the Fourth of July being a biographic film with the 9 highest NPV, the top 10 sequels excluding biographies category (see Attachment I) sports an increase in valuation of over $140,000 compared to the original top ten category. This valuation increase can be applied to every subcategory if biographies are excluded due to a decrease in the amount of movies that Arundel needs to spread the profits over. III.

Black-Scholes Model Analysis The Black-Scholes model (see Attachment II and III) is another tool used to value call

options of a certain stock. Inputs such as current stock price, strike price, time, the risk-free rate, and standard deviation are used to calculate the value of the option. Time is a variable which I manipulated because some film studios will know immediately after an original movie is released (at t = 1) if they are going to pursue creating a sequel due to box office performance. Sometimes the studios need to wait a few months in order to get the necessary reaction to determine if a sequel should be made or not. In this case t is equal to 1 (immediately know about sequel creation), 1.25 (know after 3 months), and 1.5 (know after 6 months). Note that the longer you wait after the movie release, the more expensive the option gets with time. At t=1 the call price for 1989 films is $5.36 million. If Arundel decides to wait 6 months after the release date the call price increases all the way up to 6.65 million. 1987 and 1988 have average call prices of

$8.11 million and $4.55 million respectively. Attachment IV depicts the progression of the call options prices from 1987-1989. IV.

Conclusion Arundel should make sure to keep the biographies argument in their back pocket during

negotiations. In terms of valuing the film rights, I believe the subcategory that should be given the most consideration based off of NPV analysis is the top 15 category with a valuation of $4.48 million per sequel right. I would strongly suggest to steer clear of the genre and studio subcategories and attempt to make as many of the 26 profitable sequels as Arundel logistically can without stretching your resources and capabilities.

Appendix A Attachment I – Graph of NPV Valuations (in millions)

This graph shows the breakdown of categories that I divided the 26 profitable films into. The numbers were calculated by taking their average NPV per sequel and multiplying that number by the group size (for top 15, the average NPV would be multiplied by 15). That total profit would then be divided by 99 (or in certain cases 95, excluding the biographies) in order to get the total profit or loss per sequel right. Formula: ((PV inflows / (1 + 6% discount rate) ^ 8 periods - PV costs / (1 + 6% discount rate) ^ 6 periods) * # of films in the subcategory) / 99 or 95 total films.

Attachment II – Black-Scholes Formula

Attachment III – Black-Scholes Calculation for 1989

This is for the case that we know immediately once the film comes out that there is going to be a sequel. The standard deviation is the average one year return. The current stock price is the average of net inflows of all 99 films discounted to today. The strike price is the present value of the average costs of the 99 films (costs only need discounted four times because costs are usually discounted back for six semiannual periods but we are at t=1 which subtracts two periods). The risk-free rate is 6%. All other calculations are shown with the formulas.

Attachment IV – Black-Scholes Calculation for 1989

Note the sharp decrease in option value from 1987-1988 is mostly due to a decreased one year return from 120% to 80%. Also note that the longer you wait after the release of the original film, the more valuable the option becomes....