P7-20 (similar to) Question Help You are considering making a movie. The movie i

ID: 2791447 • Letter: P

Question

P7-20 (similar to)

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You are considering making a movie. The movie is expected to cost

$10.2

million upfront and take a year to make. After that, it is expected to make

$4.3

million in the first year it is released (end of year 2) and

$1.9

million for the following four years (end of years 3 through 6) . What is the payback period of this investment? If you require a payback period of two years, will you make the movie? What is the NPV of the movie if the cost of capital is

10.5%?

According to the NPV rule, should you make this movie?

What is the payback period of this investment?

The payback period is

nothing

years.(Round up to nearest integer.)

P7-20 (similar to)

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Explanation / Answer

The movies expected cost is $10.2 million
Thus the inital outlay of the project = -10.2 million

The cashflows for year 2 = 4.3 million and 1.9 million from year 3 to 6.

Please see the calculation of Payback period and NPV at 10.5% cost of capital as below:

Formula for year 2 = Year one Cumulative cashflow + year 2 cashflow

Year

cashflow

Cumulative cashlow

-10.2

4.3

-5.9

1.9

-4

1.9

-2.1

1.9

-0.2

1.9

1.7

NPV at 10.5%

Payback period = 5+(1.9-1.7)/1.9 years

-$0.83

5.105

The payback period of this investment is 5.105 years
and if we require a payback period of two years we wont make this movie.

The NPV of the movie if the cost of capital is 10.5% is -$0.83 million
and thus using NPV rule, we shouldnt make this movie as its NPV is negative.