Submitted by,

Anil Anjum
Nisar Ahmed
Murtaza Naqvi
Omer Akif

Arundel Partners: The Sequel Project

If the first movie was a success they would exercise their right and make the sequel or sell it to
the highest bidder. Otherwise they would just write it off their investment schedule. The chances
of making a profitable business would largely depend on a good estimate of the rights present
value at the contract date. To less would not tempt the studios (inquiries indicated not less than
USD 2 million per movie) and too much would not make the business profitable.
Calculating the NPV of all the profitable sequels of a studio.
The data used assumes that the sequels estimated negative cost and US theater rentals are 120%
and 70% respectively, of the corresponding items for the first film.
In exhibit 7 we find the present value at year 4 and the PV of the negative cost at year 3 from the
hypothetical sequels. Since the right of a film give us the opportunity to decide whether investing
into the sequel is profitable, the decision is made on Year 3. If at that time the first film had no
big success, the sequel would be immediately discarded, thus no investment would be made and
the chances of loss would be null.
We will only take into account those films which have a positive NPV. From the hypothetical
sequel data from Exhibit 6 we discount the net inflows at year 4 and negative costs at year 3 to
the present time at year 0. We use discounting rate of 12 %.
Calculating NPV from the table in Exhibit 6 below shows the 26 sequel films that have a positive
NPV. The total sum of the 26 sequels account for 490.1 M$ which divided by all the 99 portfolio
sequels gives us a price of 4.95M$ per film.
Calculating the value of a right with the B-S-M model.
This approach consists of using the B-S option pricing formula to model the portfolio right of the
sequels. The variables of the BS model for a set of stochastic variables are So, K, r, T, and
sigma. And we apply it on the portfolio in the following way:
Var
So
K
R
T
Sigma

Description
the PV of the portfolio value = (21.6/(1+.12)^4=
the average negative cost of the set of films = (22.6/(1+.06)^3=
the risk free rate at 6%
the time in which the decision of making the sequel is made (Y 3)
the standard deviation of the sequels return

Value
13.71
18.97
6%
3
1.21

Using the data on Exihibit 7, we can obtain the mean values of the Portfolio value at Y4 which
we will discount to Y0 using a rate of return of 12% for risky businesses. The strike price K will
be the mean value of the negative cost of films.

The time T for the maturity of the right will be set on Y3, time in which the production of the
sequel must be decided. Finally sigma, will be the standard deviation of the one-year returns of
all the films of the portfolio. The results are summarized in the above table.
If we were to use the Call option table the inputs for moneyness (NPVq) and Cumulative
volatility would be:

NPVq = So/K = 13.71/18.97 = 0.722

Cumulative Volatility: sigma*sqrt(T) = 1.21*3 =2.095

The nearest value on the table would be 65% to equate C/S
The call price using the BS model is 65% x So = 8.91 M$ per film. This price is the fair price
considering the hypothetical revenues of the sequels. Purchasing any right at a lower value
would be profitable and vice versa.
Summary of both methods for the calculation of the rights price.
Method
NPV discounting
BS Model

Price
4.95 M$
8.91 M$

As you can see on the table above, the estimated call price for the sequels rights is quite similar.
This confirms that the theory behind estimating options pricing is correct, but whether it is truly
reliable in the real case, will only depend on the adequacy of the assumptions.
Our analysis of the proposal includes a net present value (NPV) calculation of each movie
production company. It is felt that waiting to purchase sequel rights until after the movie goes
into production will make it more difficult and costly to purchase the rights. Below are
advantages and disadvantages of the approach we took to valuing the rights.

Advantages:

Simplicity
Because all available data was used, there is a greater sample in our analysis. We assume
that more data points will lead to a more accurate conclusion.
The analysis is based upon historical data rather than fabricated assumptions.
We believe that breaking out the data by studio is an advantage because it provides
direction.

Disadvantages:

It is assumed that historical performance is indicative of future performance in the short

term based on historical data. Our assumption is supported by Exhibit 1 which shows that
all production companies tend to have similar performance over time.
Only 1 year of historical data is available
We assume that production companies are willing to sell the sequel rights under our terms.
Probabilities of success have been calculated, but we have not been able to apply them to
the per film value. In short, it is necessary to be subjective about the risk based on the
probabilities of success.