The Scientific Approach to Options Based on B&s Model

ARUNDEL PARTNERS: THE SEQUEL PROJECT

Business analysis:

1) Why do the principals of Arundel Partners think they can make profits buying movie sequel rights? [Hint: Think before answering.]

Valuation:

Estimate the value per-right of a portfolio of sequel rights using several approaches, specifying the assumptions underlying each of them.

2) First, estimate the value per-right (i.e., at the time Arundel pays for the rights) using the traditional NPV approach, ignoring embedded options.

3) Second, modify the NPV approach to try and account for the embedded option(s), explaining the nature of the option(s) you focus on. What is the implied value per right?

4) Third, use the Black-Scholes model, thinking carefully about the inputs. What is the implied value per right? [Hint: Be careful with maturity and volatility.]

Deal structure:

5) Comment on the proposed deal structure. For instance, would it make a difference to the value per-right if Arundel…

a) … negotiated film-by-film rather than buying a portfolio of rights in advance?

b) … bought rights from only one studio?

c) … were a large corporation rather than a small partnership?

6) What problems or conflicts might Arundel and studios encounter? What contractual terms would you suggest Arundel insist upon?

Assume that the nominal risk-free rate is 6% per annum, and that the appropriate discount rate for sequels' cash flows is 12% (although a bit of

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