Arundel Partners: the Sequel Project 1

Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.

We assume that Arundel Partners will purchase a portfolio of films similar to one used in the analysis. The average hypothetical net inflow of the sequel ($21.57M) is used to figure out the value of the state variable for the real options model. The state variable is the average hypothetical net inflow of the sequel, discounted using a WACC of 12.36% back to 1989. Discounting back to 1989 is important because this is

A group of investors (Arundel group) is looking into the idea of purchasing the sequel rights associated with films produced by one or more major movie studios. Movie rights are to be purchased prior to films being made. Arundel wants to come up with a decision to either purchase all the sequel rights for a studio's entire production during a specified period of time or purchase a specified number of major films. Arundel's profitability is dependent upon the price it pays for a portfolio of sequel rights. Our analysis of Arundel's proposal includes

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?

Table 7 in the detailed analysis above shows the summary of the Discounted Cash Flow analysis performed for each of the four potential properties considered for investment. From the chart below, we observe that of the four properties, TFB has the maximum increase in reversion value at the end of the holding period, i.e. 10years. On a primarily income generation potential basis, Alison Green, with a Net Present value of the future rents at $734.29 looks attractive among the four options. Looking at the Investment ranks of the four properties with Simple returns and Discounted returns variables, Alison

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

c. What is the best evidence of fair value? Describe alternate methods of estimating fair value.

It should be noted that an income approach could have also been used. Using a determined market discount rate of 6% and current year revenue of $3,028,000 at a four year discounted rate, the value would have been $12,040,548. Because adequate market information was available to make a more accurate estimate of the fair value, this is the estimate that was chosen.

2. Should Gabriela and Rob be concerned about the fair value estimate Morris Mining has computed? Why? What incentive does the company likely have in terms of valuing the patent (over or understatement)? Explain your answer.

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?

1. Evaluate the terms of the proposed $900 million financing from the perspective of both parties. How would you calculate the return to investors in this transaction? If you need more information, what information do you need?

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).

Based on our valuation of the investment, as outlined below in the Analysis portion of the report, we have determined a per-movie-value of $8.9 million when considering purchasing the rights to the entire portfolio of 99 movies analyzed in the sample data. Based on production of 10 sequels, the per-movie-value of the portfolio would be $52.25 million. Our calculations based on the hypothetical portfolio is that Arundel Partners should make this investment as long as the present value of the expected cash flows from the sequel revenues exceeds the cost of production plus the cost of the investment. Depending on what value a studio will accept as payment per sequel, there appears to be significant profitability in the investment.

2. Compute the NPV of both projects. Which would you recommend? What if they are not mutually exclusive?