Arundel Partners – The Sequels Project
After evaluation of the proposed acquisition of the movie sequel rights, we recommend to offer movie studios as a per-movie price to purchase the sequel rights for their entire portfolio of movies the studios are going to produce over the next year.
Arundel should make an offer to buy sequel rights as the average NPV (on a per film basis ) is $5.51 mn (this is the value calculated using real options method).
Hence, we should pay a price below $5.51mn. As per informal inquiries made by us, the studios would be tempted to accept the price of $2mn or more and would not even consider a price below $1mn.
We propose that we should negotiate for the price of $2mn. This would give us a profit of
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The results are as below
Studio | Average value of sequel rights per film( in $mn) | MCA UNIVERSAL | 12.3 | PARAMOUNT PICTURES | 5.12 | SONY PICTURES ENTERTAINMENT | 4.89 | TWENTIETH CENTURY FOX | 3.33 | WARNER BROTHERS | 12.17 | THE WALT DISNEY COMPANY | 17.68 | All Studios | 8.61 |
Drawbacks and improvements of the DCF analysis method
DCF models underestimate the value of investments where there are embedded options to follow up with a second investment if the first one does well (follow-on option)
1. Discount rate: The analysis assumes that the discount rate is the same for the complete throughput time of the project. This can be countered by using different discount rates for different years, in case required.
2. Static model: Once the decision to go for the project has been made, possible future changes are not taken into account anymore. It does not account for future decisions (such as hold or abandon a part of the project) based on better information or change in scenario. The NPV of the project should be split in multiple projects whereby the decision is postponed until more information is known about a particular part of the project
Valuation of Sequel rights using Real Options model
Reason to use options model
The valuation of sequel rights involves contingency. This makes options model a better tool for this analysis since it is dynamic. Using
The maximum per-film price for the sequel rights that Arundel Partners should pay is $5.12M.
- We would also like to have information about the willingness of production companies to sell sequel rights at a pre-negotiated price.
With the purchase of sequel rights, what Arundel is achieving is to have a call option on the revenue that each movie brings. This helps to remove the uncertainty and risks associated with producing a movie, especially with regard to moviegoers’ taste. With the sequel right, Arundel will only exercise this option to produce a sequel if the first movie proved to be popular and the sequel is hence predicted to bring in profits. This provides downside protection, as huge losses (due to high production costs) associated with a failed movie will be avoided.
a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?
The lowest amount the firm should accept for the contract is $2,585,000. This is the total of all of the relevant costs for the project.
Commercial’s NPV is $.1516 million (see Table 3). This was determined by using the present values of the four year lease agreement between Prudent and Commercial. We concluded that Commercial’s discount rate will be 10% because of their opportunity cost. Commercial needs to have a residual value on the DAS of 6.8 million or greater, which will give them a positive net present value. Therefore, if their net present value shows negative, they would not want to lease to us. Assuming Commercial receives the same 5 year MACRS rate on the equipment purchase, then the system should be worth 7.01 million (book value) at the end of year 4 (see Table 4). This allows Commercial to have a positive NPV of $.1516 million (see Table 4). Therefore, they would be willing to lease the DAS to us.
Main Line is also not entitled to the differential profit loss by comparing Basinger films to Fenn films. It is understandable how Main Line thinks they are because Basinger films do make more than Fenn films, but who can say with certainty that this would have been the case in Boxing Helena--a controversial and unconventional film to say the least. Again I direct your attention to the Bruce Willis and Whoopi Goldberg movie flop argument.
NaviNow will pay $8 million to the four former owners of TrafficEye if revenues from the combined system exceed $100 million over the next 3 years. NaviNow estimates this contingent payment to have a probability adjusted present value of $4million. According to down said formula (http://www.ey.com/Global/assets.nsf/United%20Accounting/ATG_FRD_BB1616/$file/ATG_FRD_BB1616.pdf)
Arundel can make money selling the rights to a higher bid. Another option to make money is by producing the sequel exercising its rights but this will depend on if the net present value of the production movies is higher than the amount of buying the rights. If the future positive cashflows are undervalued Arundel can seek an arbitrage
At a price of $18.80 per square foot ($1,500,000/80,000 square feet), the deal seems in line with recent sales in the area as seen in Exhibit 5.
5. Assume that a maximum of ten sequels can be made in any given year (choose the sequels that are most likely to be made—for example if the main character in the film dies then a sequel is unlikely to be made) 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?
However, United Chemical's offer of $160 million is well under the value of the IPD. According to our valuation, Nova could sell IPD for a price between $256 million and $501 million.
In other words, the price has to be justified and not seem like an arbitrary number. Slaoui and Witty managed to this by emphasizing on Sirtris’ strengths in terms of their research, but particularly in terms of the actual field Sirtris is engaged in, that could potentially be a transformative science allowing for the development of multiple drugs that have the potential of treating diabetes and other diseases that promise a high turnover when launched. In other words, I would make sure that the members of the board are able to see the potential benefits and above all profits of the respective acquisition.
The discounted cash flows seems like a simpler approach, with a less complex method to compute the value of the sequels and easier to understand, both for Arundel Partners and for the studios. It requires only a few variables (inflows and costs in this example) and gives the intrinsic value of the project that is being analyzed, not a comparison against similar projects.
“Ensuring the requisite skills” - disagreement on price with Sales, Design, and Development teams causes conflict and lack of collaboration;