Arundel Partners Case
1. Why do the principals of Arundel Partners think they can make money buying movie sequel rights? Why do the partners want to buy a portfolio of rights in advance rather than negotiating movie-by-movie to buy them?
The movie industry is a very risky business and predicting a success of a movie is very difficult to do. In response to this problem, the Arundel Partners developed a strategy which is to buy portfolio of rights to sequels instead of by film-by-film. Just like a portfolio of stock, they are hoping to minimize risk by believing that the sequels that will be produced based on the success first movie will outweigh the cost of acquiring those portfolios of sequels. Furthermore, the Arundel Partners, once acquired the rights, can use the right as an option. For instance, if the first movie is a blockbuster movie, the Arundel can exercise the option and produce the sequel. However, if the first movie doesnt turn out so well, they can sell the rights back to the studio or to a third-party who is willing to take on this project.
The Arundel Partners wants to buy a portfolio of rights in advance because both parties, the Arundel Partners and the studio, cannot predict the future success of the movie before production. If the contract was negotiated after the production began, the studios might have knowledge about the success of the movie that Arundel Partners dont have. This would result in the studio increasing the price the rights or choosing to not to sell the rights at all, which could be problematic to the Arundel Partners.
2. Estimate the per-movie value of a portfolio of sequel rights such as Arundel proposes to buy. Use both a discounted cash flow (DCF) approach and Black-Scholes option valuation approach.
Using the DCF method
Arundel is going to decide whether to continue with the sequel based on the success of the first movie. So we need to know the movies that have positive net present value at time 0 because these movies are the ones that are going to have sequels. So we can ignore the movies that have negative present value since these movies are insignificant to our analysis. Using the cost of capital at 12% as the discount rate which was given, we see that 42 movies have a positive net present value. Once we know the movies with positive net present value, we can find the net present value of the sequels of those 42 movies. This gives us the value of $440.12 million. Dividing this number by the total numbers of movie which is 99, we have $4.45 million. This value is greater than $2 million, which is the value that studio is willing to exchange for sequels rights according to the article.
Using the Black-Scholes Method
Unlike DCF, Black-Scholes incorporates the option of exercising the rights of the sequel. We need to first identify the components of the Black-Scholes