Fox Searchlight Pictures recently purchased a script for a new movie about a pok
ID: 2817050 • Letter: F
Question
Fox Searchlight Pictures recently purchased a script for a new movie about a poker player. It will cost $40 million to produce the movie (which is fixed regardless of when it is produced). Following the production of the movie today, the cash flow to be generated from the movie in year 1 will be $40 million with 25% chance or $10 million with 75% chance. From year 2, the movie will generate $5 million, which will decline by 5% per year forever. Given the growing popularity of the poker game, the producer believes that it may be better to delay the decision of movie production for a year. In year 1, the uncertainty about the first cash flow to be generated from the movie one year after production ($40 million or $10 million) will be resolved. The remaining cash flows will be the same as above (that is, the second cash flow will be $5 million, which will decline by 5% per year forever). The firm requires at least 15% on the project. Do not consider any other factors.
(a) What is the NPV of the project if the firm needs to decide today whether to invest in the project?
(b) What is the embedded real option in this project? Can the real option be regarded as a call option or a put option? Identify the underlying asset and the exercise price of the option.
(c) Is the project worthwhile if considering the real option?
(d) Should the firm need to produce the movie now or wait a year?
Explanation / Answer
A genuine choice is the right, however not the commitment, to settle on a choice around an interest in genuine resources,
While the hidden resources on which genuine choices determine their value are by and large not exchanged aggressive markets .
At the point when there isn't an alternative to pause, it is ideal to put resources into any positive-NPV venture instantly. At the point when there exists the alternative of postponing the acknowledgment of a task, it is generally ideal to contribute just when the NPV is significantly more noteworthy than zero.
Cost of creating motion pictures = $40m
Firm requires no less than 15% on the venture implies the cost of capital is 15%
Trade stream out year 1 $40 million with 25% possibility
$10m with 75% possibility
Year 2 creates $5m which decays by 5% for each annum for ever.
Postpone the motion picture creation by 1 year, the vulnerability about the primary income to be created from the film one year after generation ($40 million or $10 million) will be settled.
Yearly expected income = 0.25x40 + 0.75x10= 10 +7.5=$17.5
Net present value(NPV)= - cost + income/(1+cost of capital) + trade stream out second year/cost of capital)/1+cost of capital
NPV= - 40m+ 17.5/(1+.15) + (5/.15)/(1+.15)= - 40m+ 17.5/1.15+ 33.34/1.15= - 40+15.21+28.99=$4.2
Task has an alternative to defer
NPV of task if there is increment in notoriety
NPV= - $40m+ 40/(1+.15) +( 5/.15)/(1+0.15)=-40+40/1.15+33.34/1.15=-40+34.78+28.99=$23.77
The NPV of undertaking if there is no expansion in notoriety
NPV=-40m+ 10/(1+1.15) +(5/.15)/1.15=-40+8.69+28.99= - $2.32
Decide the estimation of the undertaking and alternative adjustments.
The project value, net of the underlying venture is:
0 year
1 year
63.77
high popularity
44.2
37.68
same popularity
option pay off
0 year
1 year
23.77
high popularity
C
-2.32
same popularity
We need to compute the probability =(1+rf) S-Sd/(Su-Sd) = (1+0)44.2-37.68/63.77-37.68
= 6.52/26.09=.25
1. =1..25=.75
Option value = C=Cu+(1-)Cd/(1+Rf)= 0.25(23.77) +0.75(- 2.32)=5.94-1.74=4.2
The option value is equivalent to NPV 4.2
The value today from holding up to put resources into the motion picture one year from now is $4.2 million. This value breaks even with the NPV of $4.2 million from contributing today. the task is advantageous if considering the genuine choice as the option value is positive.The firm should create the motion picture now.
0 year
1 year
63.77
high popularity
44.2
37.68
same popularity
option pay off
0 year
1 year
23.77
high popularity
C
-2.32
same popularity
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