Valuacion Arundel

Assignment 10

1. Read and study “Introduction to Real Options”

2. Read and study CH 17 from McDonald: “Real Options”

3. Read and study CH33 from Hull: “Real Options”

4. Case: Arundel Partners: The Sequel Project

Answer the following questions:

a. What makes Arundel think it can make money by buying a package of sequel rights? Is the profit opportunity, if it exists, likely to be sustainable?

Arundel can make money selling the rights to a higher bid. Another option to make money is by producing the sequel exercising its rights but this will depend on if the net present value of the production movies is higher than the amount of buying the rights.  If the future positive cashflows are undervalued Arundel can seek an arbitrage opportunity and buy the rights at the market price.

b. Why would the studios be interested in raising money in this fashion? Why not raise the money in more traditional ways?

The studio can not raise money in a traditional way because they don´t know when the movie will be popular o not so they don’t have regular cashflows. They also think that the business of movies production can be profitable by selling sequel rights ( this can be perform as an option).  If a movie performs with positive cashflows they can invest in the movie production and have profits. The risk here is lower because they don´t have the same risk than the traditional ways of raise money like an asset.

c. Why should Arundel pay anything for the sequel rights? The average movie loses money, and a sequel is more costly and has less revenue. A naïve movie application of DCF, for example, yields a per-film sequel value of –US$2.4M ( = average present value of inflows of 21.6 (at t = 4) minus the average present value costs of 22.6 (at t = 3), discounted appropriately). How might you refine this approach?

I will refine this approach by valuating with black Scholes model instead of DCF, changing the beta of this valuation. The volatility and time will be in constant change.

They can invest on production and earn profit without exercising the option.

d. Explain how a sequel right can be viewed as a call option:

1. What is the underlying asset?

The sequel right will be the underlying asset and the cashflows are the assets, which depend on the underlying asset. It does not matter if the sequel have positive cashflows or not, the option will be the cashflows.

1. What is the exercise price?

When you have a negative present value or cost of production will be the exercise price.

1. What is the time to maturity?

1 Year.

1. How might you estimate the volatility?

Calculating  the standard deviation of the 1 year return. The standard deviation is 2.07.