Question

Suppose that Disney is considering one more Toy Story movie. The company is not confident in box office sales, but they do believe that the file will create merchandising opportunities (DVDs, toys, clothes,..etc). Their early analysis believes the move will have an NPV of -$38.00 million if you only look at ticket sales in the theater. However, they also believe that the movie will create sales of $72.00 million per year in merchandise. The merchandise sales will decline each year by 20.00% in perpetuity. Let’s assume that after-tax operating margin on these sales is 10.00%, and that Disney has a cost of capital at 9.00%.

What is the cash flow created by the merchandise side effect in the first year? (answer in terms of millions, so 1,000,000 would be 1.00)

Let’s value this as a perpetuity. The merchandise sales will continue indefinitely, BUT the sales will decrease each year. What is the net NPV for creating the movie? (answer in terms of millions, so 1,000,000 would be 1.00)

Answer 1

1. What is the cash flow created by the merchandise side effect in the first year?

Cash Flow Created = Sales * Operating margin

Cash Flow Created = $72 M * 10%

Cash Flow Created = $7.20 M

2. Let’s value this as a perpetuity. The merchandise sales will continue indefinitely, BUT the sales will decrease each year. What is the net NPV for creating the movie? (answer in terms of millions, so 1,000,000 would be 1.00)

Present Value of Merchandise Sales = Year 1 Merchandise Cash Flow * (1 - Discount) / (Cost of capital + Discount Rate)

Present Value of Merchandise Sales = $7.2 M * (1 - 0.20) / (9% + 20%)

Present Value of Merchandise Sales = $19.86 Million

Net NPV = Current NPV + Present Value of merchandise sales

Net NPV = -$38.00 M + $19.86 Million

Net NPV = -$18.14