Question

You are considering making a movie. The movie is expected to cost $ 10.7 million up front and take a year to produce. After​ that, it is expected to make $ 4.6 million in the year it is released and $ 2.2 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 10.3 %​?

Answer 1

1)

Payback period:

Cumulative cash flow for year 0 = -10,700,000

Cumulative cash flow for year 1 = -10,700,000 + 4,600,000 = -6,100,000

Cumulative cash flow for year 2 = -6,100,000 + 2,200,000 = -3,900,000

Cumulative cash flow for year 3 = -3,900,000 + 2,200,000 = -1,700,000

Cumulative cash flow for year 4 = -1,700,000 + 2,200,000 = 500,000

1,700,000 / 2,200,000 = 0.77

Payback period = 3 + 0.77 = 3.77 years

You will NOT make the movie as the payback period is more than 2

2)

NPV = Present value of cash inflows - present value of cash outflows

NPV = -10,700,000 + 4,600,000 / (1 + 0.103)¹ + 2,200,000 / (1 + 0.103)² + 2,200,000 / (1 + 0.103)³ + 2,200,000 / (1 + 0.103)⁴ + 2,200,000 / (1 + 0.103)⁵

NPV = -247,909.39

It does NOT have positive NPV