Question

Chapter 7

You are considering making a movie. The movie is expected to cost $ 10.3 million upfront and take a year to make. After​ that, it is expected to make $ 4.6 million in the first year it is released​ (end of year​ 2) and $ 2.2 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? Does the movie have positive NPV if the cost of capital is 10.7 %​?

What is the payback period of this​ investment?

The payback period is ____years.

Answer 1

Lets make a table with the cashflows of the movie.

Time Period	T0	T1	T2	T3	T4	T5	T6
Cashflows	-10.3		4.6	2.2	2.2	2.2	2.2

From the above information, cumulative cashflows till Year 4 is 4.6+2.2+2.2=9. Remaining cashflow needed for covering the investment is 10.3-9= 1.3. It can be revovered in 5th year, in 1.3/2.2= 59.1% of the year.

So, Payback period is 4+0.591= 4.591 Years.

If we require a payback period of two years, we should not make this movie.

Calculating NPV with cost of capital of 10.7%, we get -10.3+4.6/1.107^2+2.2/1.107^3+2.2/1.107^4+2.2/1.107^5+2.2/1.107^6= -0.94

So, the movie has negative NPV, if the cost of capital is 10.7%

Payback period is 4.591 Years.