Estimate the Per-Film Value of a Portfolio of Sequel Rights Such as Arundel Proposes to Buy.

The first approach to estimate the per-film value of a portfolio of sequel rights is the DCF approach. Initially, we collect the movie whose one-year return of hypothetical sequel is greater than the cost of capital of Arundel, 12%. In other words, we find the movie with positive NPV. From Exhibit 7 we know that the number of movie meets the requirement is 26. Because the sequel production is determined by a positive NPV, we generate the total net inflows and total negative cost of these 26 movies, which is $1486.5 in year 4 and $637.60 million in year 3. We then discount the net inflows to year 3 at discount rate of 12%, then divide both net inflow and negative cost by 26 and get the average $51.05 million inflow and $24.52 million negative cost at year 3. Thus the average NPV of the sequel with positive is $26.52 million at year 3 and $18.88 million after the discount. After multiplying $18.88 and 26, we can get the total value of the sequel right portfolio, which is $490.87 million. Then we divide the number by 99. As a result, the per-film value of the 99 movies portfolio is $4.96 million.

Apart from DCF approach, we used Black-Scholes model to calculate the value of the investment. The Arundel Partners can buy the right(option) to produce the movie for a certain cost. If the portfolio is profitable, Arundel can exercise the right and get profit. Otherwise, the lost is the cost to buy the option. Several inputs should be calculated using this method. The S0 stock price (present value of the portfolio), exercise price (K), standard deviation (σ), risk-free rate (r) and the final decision time (T).

--S0 : (The present value of the portfolio): In this case, the present value of the portfolio is the present value of net inflow at Year 0. We took the average PV of 99 sequels’ net inflow at Year 4 $21.58, which is provided in the exhibit 7 in the case, discounted it back to Year 0, using the discount rate 12% that is used in DCF approach, and get $13.71 million.

Exercise price (K): Exercise price is the present value of the average negative cost of the set of films at Year 0. We took the average PV of negative cost at Year 3, which is provided in the Exhibit 7, discounted it back to Year 0 using 12% get $16.11 million.

Standard deviation (σ): 1.21 from Exhibit 7.

Risk-free rate: We took the 9.09%(nominal 10-year treasury bond return rate in 1989), with the inflation rate 3% given in the case, the effective risk free rate can be calculated as 6%.

T: The final decision time is the period between the time in purchasing the option and the time in exercising the option. The option is purchased in Year 0 and there is one year for Arundel to decide whether to exercise the right or not, because the first film will be released in Year 1. So the final decision time T is 1.

Summarizing all calculations, the value of call option is $5.85 million.