1. You are considering financing a new blockbuster movie. It will cost $90 million to make this movie (you have to pay this up front, at time t=0). There is a 70% chance it is not successful, in which case it will produce a cash flow of $55 million in one year (at time t=1). There is a 30% chance it is a success, in which case it will produce a cash flow of $180 million in one year (t=1). Draw the binomial tree for the movie. What is the expected cash flow at t=1? What is the expected NPV using a discount rate of 11%?
2. Now consider the option to expand. If the first movie is a success, then a sequel will be made (production cost of $260 million at time t=1). The sequel will be a success 85% of the time, in which case it will produce a cash flow of $880 million at time t=2, otherwise there is a 15% chance it's not a success and produces a $240 million cash flow at time t=2. Draw the 2-period binomial tree for the movie, including the sequel. What is the expected NPV in this case? (note: use the same discount rate as part a)