Arundel Partners Case
Arundel Partners: The Sequel Project
The maximum per-film price for the sequel rights that Arundel Partners should pay is $5.12M.
If Arundel Partners were to use the traditional DCF methods to find the value of the sequel rights, the NPV would be -$8.42M loss per-film (see Appendix 1).
Calculation Details
We assume that Arundel Partners will purchase a portfolio of films similar to one used in the analysis. The average hypothetical net inflow of the sequel ($21.57M) is used to figure out the value of the state variable for the real options model. The state variable is the average hypothetical net inflow of the sequel, discounted using a WACC of 12.36% back to 1989. Discounting back to 1989 is important because this is the time of the first film’s release. Within several weeks of release, the film’s success is known. This starting point value is $13.53M.
This state variable is unaffected by managerial actions and describes the main source of risk that affects the sequel rights exercise option under consideration.
Parameters
Values
Avg. Hypothetical Net Inflow of Sequel
$21.57
Avg Hypothetical Negative Cost of Sequel
$22.67
WACC (based on 6% semiannual discount rate)
12.36%
Avg. Hypothetical Net Inflow of Sequel (discounted to Year 0)
$13.53
∆T
0.083
σ
121%
exp(σ√∆T)
1.418
U (continuously compounded returns in up step in binomial tree)
1.418
D (down step in binomial tree)
0.705
risk-free rate (based on 10yr US Treasury rate in 1992)
7.03%
exp(r∆T)
1.006
q (risk-neutral probability of up move, using Lognormal model)
0.422
Avg Hypothetical Negative Cost of Sequel (discounted to Year 2)
$19.79
Table of the parameters and values used to build the binomial trees and find the option price.
Building the Binomial Tree for Asset Values
The binomial model is used to see how the state variable evolves over time, specifically over a time period of 12 months (see Exhibit 1). The maturity or expiration date of the sequel rights option is set for 12 months. Within the
The maximum per-film price for the sequel rights that Arundel Partners should pay is $5.12M.
If Arundel Partners were to use the traditional DCF methods to find the value of the sequel rights, the NPV would be -$8.42M loss per-film (see Appendix 1).
Calculation Details
We assume that Arundel Partners will purchase a portfolio of films similar to one used in the analysis. The average hypothetical net inflow of the sequel ($21.57M) is used to figure out the value of the state variable for the real options model. The state variable is the average hypothetical net inflow of the sequel, discounted using a WACC of 12.36% back to 1989. Discounting back to 1989 is important because this is the time of the first film’s release. Within several weeks of release, the film’s success is known. This starting point value is $13.53M.
This state variable is unaffected by managerial actions and describes the main source of risk that affects the sequel rights exercise option under consideration.
Parameters
Values
Avg. Hypothetical Net Inflow of Sequel
$21.57
Avg Hypothetical Negative Cost of Sequel
$22.67
WACC (based on 6% semiannual discount rate)
12.36%
Avg. Hypothetical Net Inflow of Sequel (discounted to Year 0)
$13.53
∆T
0.083
σ
121%
exp(σ√∆T)
1.418
U (continuously compounded returns in up step in binomial tree)
1.418
D (down step in binomial tree)
0.705
risk-free rate (based on 10yr US Treasury rate in 1992)
7.03%
exp(r∆T)
1.006
q (risk-neutral probability of up move, using Lognormal model)
0.422
Avg Hypothetical Negative Cost of Sequel (discounted to Year 2)
$19.79
Table of the parameters and values used to build the binomial trees and find the option price.
Building the Binomial Tree for Asset Values
The binomial model is used to see how the state variable evolves over time, specifically over a time period of 12 months (see Exhibit 1). The maturity or expiration date of the sequel rights option is set for 12 months. Within the