Question

You are considering making a movie. The movie is expected to cost $10.5 million upfront and take a year to make. After​ that, it is expected to make $4.5 million in the first year it is released​ (end of year​ 2) and $1.8 million for the following four years​ (end of years 3 through​ 6) . What is the payback period of this​ investment? If you require a payback period of two​ years, will you make the​ movie? What is the NPV of the movie if the cost of capital is 10.5%​? According to the NPV​ rule, should you make this​ movie?

There are four parts to the question written above. Please answer all parts. Thank you.

Answer 1

The Cumulative Cashflows are as shown in table below

	Figures in Million Dollars
Year	Cashflows	Cumulative Cashflows
0	-10.5	-10.5
1	0	-10.5
2	4.5	-6
3	1.8	-4.2
4	1.8	-2.4
5	1.8	-0.6
6	1.8	1.2

As Cumulative Cashflows turn positive in 6th year

Payback period = 5+ 0.6/1.8 = 5.33 years

If a payback period of 2 years is required , I will not make the movie

NPV = -10.5+4.5/1.105^2+1.8/1.105^3+1.8/1.105^4+1.8/1.105^5+1.8/1.105^6

= -2.1918

So, NPV of the movie is -$2.1918 million

As the NPV is negative, I will not make the movie