Young screenwriter Carl Draper has just finished his first script. It has action

Question

Young screenwriter Carl Draper has just finished his first script. It has action, drama, and humor, and he thinks it will be a blockbuster. He takes the script to every motion picture studio in town and tries to sell it but to no avail. Finally, ACME studios offers to buy the script for either (a) $10,000 or (b) 1 percent of the movie’s profits. There are two decisions the studio will have to make. First is to decide if the script is good or bad, and second if the movie is good or bad. First, there is a 90 percent chance that the script is bad. If it is bad, the studio does nothing more and throws the script out. If the script is good, they will shoot the movie. After the movie is shot, the studio will review it, and there is a 60 percent chance that the movie is bad. If the movie is bad, the movie will not be promoted and will not turn a profit. If the movie is good, the studio will promote heavily; the average profit for this type of movie is $15.6 million. Carl rejects the $10,000 and says he wants the 1 percent of profits. What is value of accepting one percent of the profits? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) Payment to screenwriter $ Which payment option should Carl accept? percentage of the profit upfront offer

Explanation / Answer

Soln: Here, we will calculate the 1% profit with the 2 given conditions, Lets say the value of profit to screen writerwill be V in case of 1%

1) If script is Bad , in that case only 10% chances are there.

2) If movie is bad. chance of movie is bad is 60% and no profit. So, 40% chance to promote a movie or earn profit.

So, V = 10% *40%*1%* average profit = 0.1*0.4*0.01*15.6 million = $6240

So, Carl should accept the first offer i.e. $10000 instead of 1% of profit offer as in latter case profits are lower.

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