Submitted by: Submitted by utatch
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Category: Business and Industry
Date Submitted: 12/11/2011 04:02 PM
Arundel Partners’ rationale for buying a portfolio of sequel rights (instead of for single films) is so that it can benefit from diversification: successful sequels can make up for the lost value of the motion pictures that will not yield sequels. Although there is no guarantee that any movie will spin-off into a sequel, Arundel would benefit from procuring these options prior to the first film’s production. By providing capital to studios during pre-production, Arundel could possibly obtain the rights at a discount because funding is in high demand during this stage in the process. If it tried to purchase the rights after it became apparent that the original film was a success, the studios would likely charge a premium because they would have higher bargaining power due to information asymmetry. Arundel would also have to compete with other bidders for film rights, which would increase the amount it would have to pay.
Using Discounted Cash Flow techniques to value sequel rights would not be appropriate. The DCF method ignores Arundel’s option to abandon a sequel project if the first film is unsuccessful, which would undervalue the rights. To illustrate, we calculated the average net present value for all 99 sequels by offsetting the present value of net cash flows with the negative costs. We arrived at an average sequel value of negative $1.1 million. This valuation assumes that studios would still create a sequel even though the first film was not profitable, which is not a realistic assumption.
To find the per-film value of the portfolio of sequel rights, we used real options based on the present values of the first films and the hypothetical sequels listed in Exhibit 7. First, we found the probability that the first film would be successful, defining success as a positive return, which was equal to .475. Then, we found the probability that a sequel would have a positive return following a successful first film to be .596. For the 28 sequels that met...