Arundel Partners

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Case Write-Up: Arundel Partners 15.415 Finance Theory Section B, Oysters Arundel Partners: The Sequel Project 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. Arundel plans to agree on the number of films and price per film…show more content…
The company will not exercise the sequel right if they predict that the sequel will not be profitable based on the first movies’ performances. The downside of the investment is removed when we purchase the sequel right. To get an estimate of the call price, we use the average of PV of net inflows as the underlying asset, PV of negative costs as exercise price, standard deviation of return as volatility, and 1992 T-bill rate as the risk free rate. After plugging in these numbers into the Black-Scholes formula, we calculated that the average cost for a sequel option should be 9.2728. The main assumption we are making here is that our call option (sequel right) is for an average movie (i.e. if we decide to buy the right, we are willing to pay an average call option price of 9.2728 for each movie regardless of the studio it is produced from). However, in reality, the company will be negotiating the prices of the sequel rights with each studio. Thus, the quoted price we will get from each studio can be quite different from the overall average price we calculated since each studio’s expected performance is different from one another. The volatility we used is the industry volatility approximated from the standard deviation of returns from 99 movies’ sequel. When we are evaluating a quoted price of a sequel right, 9.2728 will be a good bench mark. According to our simple NPV analysis, we would reject the

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