Question

You are considering making a movie. The movie is expected to cost $10.6 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 $1.9 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 10.2%​?

Answer 1

Initial Investment = $10.6m

cash flow in year 1 = 4.6

Cash flow in year 2 = 4.6 + 1.9 = 6.6

Cash flow in year 3 = 6.6 + 1.9 = 8.4

Cash flow in year 4 = 8.4 + 1.9 = 10.3

Cash flow in year 5 = 10.3 + 1.9 = 12.2

Hence, payback period lies between year 4 and year 5.

Exact payback period = 4 + (10.6-10.3) / 1.9 * 12 = 4 years 2 months

If my payback period is 2 years, won't make the movie.

For NPV, we need discounted value of the cash flow

Discounted cash flow for year 1 = 4.6 / (1.102)^1 = 4.174

Discounted cash flow for year 2 = 1.9 / (1.102)^2 = 1.564

Discounted cash flow for year 3 = 1.9 / (1.102)^3 = 1.419

Discounted cash flow for year 4 = 1.9 / (1.102)^4 = 1.288

Discounted cash flow for year 5 = 1.9 / (1.102)^5 = 1.169

Total cash flow received = 4.174 + 1.564 + 1.419 + 1.288 + 1.169 = 9.615

NPV = -10.6 + 9.615 = -0.984

Hence, the movie has negative NPV