What kind of an option is this in terms of the three


Arundel Partners: The Sequel Project Notes and Instructions

Case Instructions

Look at the ten movies Paramount released in 1989. (These are given in the case in Exhibit 7. (Exhibit 7 spreadsheet.) Answers should be done in an Excel file when you are done.

(1) For each movie, say whether you would or would not exercise the option to make the sequel. Briefly explain the decision rule you are using, and show any calculations you make as part of this decision rule.

Your answer should be based on the numbers in Exhibit 7. Do not use movies from any other studio, and do not base your decision on whether a sequel was actually made after the time of the case!

(2) Using the information on the ten hypothetical sequels from the previous question, what is the most you would pay at Year 0 for these sequel rights on a per-film basis? Show all calculations, explaining what you are doing.

Some Key Facts from the Case

Arundel will buy rights to make sequels on movies. We want to value this right, using information from case.

Exhibit 6 gives data on original films released in 1989.

There are two key components:
(1) Negative cost.
(2) Other cash flows.

Also, Mr. Davis constructs hypothetical sequel, using facts from Exhibit 4 and elsewhere:

(1) Exhibit 4: negative cost of sequel averages 120% of original's, in constant dollars. Why higher?

(2) Same exhibit: US theater rentals average only 70% of original's, in constant dollars. Why lower?

Discounting this is messy-need to track timing, etc. Fortunately, Mr. Davis has done this in Exhibit 7:

First, he spreads and present value negative costs for original as of Year 0 (when start production of original film).

Discount at "6% semi-annually" = 12.36%/year, since (1.06)2 = 1.1236.

Then he spreads and present values all other flows as of Year 1. Why Year 1?

Then he does the same for a hypothetical sequel, assuming production starts three years after

Year 0. Why wait three years?

And he assumes inflation is 3%/year compounded semiannually (3.02%).

The Sequel Project as a "Real Option"

(1) What kind of an option is this, in terms of the three investment project options we discussed (timing, follow-on, abandon)? Why?

(2) Is this like a put option or like a call option?

(3) What is the underlying asset for this option?

(4) In words, what is the exercise price of this option?

(5) If Year 0 is the start of production for the original movie, when is Arundel most likely to exercise its option?

Need spreadsheet answer and written explanation as outlined in the attached instructions. Need an expert in corporate financial management.

Attachment:- Arundel Partners - Exhibit 7.xlsx

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Financial Management: What kind of an option is this in terms of the three
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