Arundel Partners Case Essay Example

Arundel will have an option to producing movies and will just forgo those which supposedly will not make any profit, we can only focus on those which made profit in past. Average negative cost for these movies at year 3 is 24. 52 and average net inflows at year 4 are 57. 17.

Thus NPV for these movies will be 57. 17/1. 124-24. 52/1. 123=18. 88.

This result, extrapolated to “the universe” of the movies will give us an NPV per movie of (26/99) * 18. 88 = $4. 96 million per movie.

Option calculation.

We know if we are going to make a sequel at year 1. Option will be exercises at year 3. Cost of production is the strike (K). Average K for all movies is 22. 64. Asset value (S0) would be the cash inflows (average 21.57 per movie). PV(S0) = 21. 57/1. 124=13.71. Standard deviation of the return is 1. 21 for year 1; since this is the year when decision is made, in year 1-3 deviation is 0. Therefore average standard deviation over whole period will be v(1/3 ? ^2 )=0. 70.

The main question for NPV calculation is 12% discount rate – options are more volatile and risky and should be discounted using higher discount rate.

Question for Black-Scholes – why do we use lognormal distribution? Is it appropriate here? Another question is whether the movies in the movie population is comparable and more or less same.