Question

You are considering making a movie. The movie is expected to cost $10.4 million up front and take a year to produce. After​ that, it is expected to make $4.9 million in the year it is released and $1.6 million for the following four years. What is the payback period of this​ investment? If you require a payback period of two​ years, will you make the​ movie? Does the movie have positive NPV if the cost of capital is 10.1%​?

What is the payback period of this​ investment?  

The payback period is ____ years.  ​(Round to one decimal​ place.)

Answer 1

Project cash flows are as below

Year	0	1	2	3	4	5
Cash flow	-10.4	4.9	1.6	1.6	1.6	1.6
Cumulative cash flow	-10.4	-5.5	-3.9	-2.3	-0.7	0.9

As annual cash flows from the project are not equal, payback period = last year of negative cumulative cash flow + (absolute value of cumulative cash flow in that year / cash flow in the following year) = 4 + (0.7 / 1.6) = 4.4 years

i.e. payback period = 4.4 years

Given that payback period of the movie is greater than two years, we will not make the movie if required payback period is two years.

NPV can be calculated in excel using = NPV(10.1%,-10.4,4.9,1.6,1.6,1.6,1.6) = -$1.2.

Thus, the movie has negative NPV if cost of capital is 10.1%.