Case Write-Up
Arundel Partners: The Sequel
Rodrigo Chanin | Armando Chekerdemian | Jonathan Stein | German F. Vega | Gabriel Xavier
Corporate Finance MBA 777 SECTION 9:30 am
Executive Summary
Arundel Partners' attempt to purchase the rights to the movie sequels of a major studio should follow a Call option as to allow them to eliminate the risk of financing a non-profitable sequel.
Overall, we recommend that Arundel place a starting bid of $1. 85M and bid up to $2. 88M to pursue a profit margin of at least $2. 34M per movie.
The Agreement
Arundel expects to make money by acquiring the rights to all movie sequels for a movie producer before the true value is priced in. If Arundel determines that a movie is profitable enough to have a successful sequel, it will exercise its right for the sequel and decide to produce it itself or outsource production to a third party. Through this contract, Arundel can rescind production of a sequel that it considers unprofitable and focus only on box office hits.
On the other hand, movie producers benefit by receiving cash in advance that can be used to fund the current stages of a movie's production. Arundel brings funding to the table while taking much of the risk away from the studios producing the films in the form of less debt. Thus, movie studios gain funding for current projects, allowing them to use less leverage during production of a product with highly volatile returns.
Overall, this posed the question on what is the best way to value this arrangement. Should be it through a traditional Discounted Cash Flows approach or should an Options Pricing provide a more exact value? The follow sections consider these analyses.
Agreement Valuation | Traditional DCF Approach
Contract valuation through a traditional DCF required estimating two major components: the cost of capital and the expected cash flows for each movie. In terms of the cost of capital, we recommend to go forward with an annual cost of capital of 10. 8%. This variable was calculated by applying a traditional CAPM with specific data for the Entertainment Industry. Exhibit 1 presents full details on the calculation of these values and the sources used for the analysis.
Regarding the expected cash flows, we decided to take a two-fold approach to this analysis. First, we decided to calculate the net cash flows as the Present Value of Net Inflows less the Negative Costs per movie using the data of all 99 titles and their hypothetical sequels for all films released in 1991 by the Six Major Studios. As show in Exhibit 2, this valuation implied a net present value of -$2. 34M per movie, which implied that on average, purchasing movie sequels would not allow Arundel to make money out of this arrangement.
Second, to improve on this analysis, we recommend to consider only the Net Present Value of the movies with positive cash flows, but dilute the benefits across all available movies. We called t...
