You are considering financing a new blockbuster movie. It will cost $90 million

Question

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%? 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? (use the same discount rate as )

Explanation / Answer

a. The Cost is 90 Million

The cash inflow is(at t=1) = 0.7*55 +0.3*180 = 92.5 Million

Discount rate = 11%

hence the NPV at (t=0) = 92.5/1.11 - 90 = -$6.67 Million (negative)

b. The cost at (t=1) = 260 Million

The inflows at(t=2) = 0.85*880 + 0.15 * 240 =784 Million

NPV at (t=0) is = 784/1.11 - 260 = 446.31 Million

Now NPV at( t= 0) = 446.31/1.11 - 6.67 = 379.67 Million

Since the probabilty of success is only 0.3 the value at t =0 , the NPV = 379.67 *0.3 = 113.90

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.