In 1992, Arundel Partners was looking into the idea of purchasing the sequel rights associated with films produced by one or more major movie studios. Movie rights were to be purchased prior to films being made. Arundel wanted to determine if this innovative business strategy is viable by estimating the value of the sequel rights.
Our report aims to investigate the viability of the implementation of Arundel's strategy in purchasing sequel rights to produce potential successful movie sequels. The discount cash flow (DCF) approach and the real option pricing approach were adopted in valuing the sequel rights purchased by Arundel respectively. The value of these sequel rights is then compared to the …show more content…
5. REAL OPTION APPROACH
The real option approach is used as the second approach in estimating the value of sequel rights. This approach can be contrasted with the DCF approach as it takes into account the option of exercising their sequel rights.
The Black-Scholes option formula is used to calculate the value of the option of exercising the sequel rights. Different valuables needed for the formula needs to be identified first in order to obtain an estimate of the value of the option of exercising the sequel rights.
Here Φ is the standard normal cumulative distribution function.
Before we go on to calculate the values for the different valuables used in the Black-Scholes formula, we will need to first identify our underlying asset for the option of exercising sequel rights.
Just as the underlying asset behind the option to purchase a stock is the stock itself, the underlying asset behind the option to produce a movie sequel is the actual movie sequel itself!
With the above in mind, we will go on to calculate the different variables needed in the Black-Scholes formula. They are namely the strike price (S), the exercise price (E), the time to maturity (t) and lastly the standard deviation on the return of the underlying asset ().
Strike Price (S)