Question

You are considering making a movie. The movie is expected to cost $10.2 million upfront and take a year to make. After​ that, it is expected to make $4.5 million in the first year it is released​ (end of year​ 2) and $1.9 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? What is the NPV of the movie if the cost of capital is 10.1%​? According to the NPV​ rule, should you make this​ movie?

(NPV is not -1.537 million)

Answer 1

Paypack period is the time taken by the future (undiscouted) cash inflows to re-earn the invested amount.

This is how the cash flow time line looks like:

So, the amount of investment in this case is $10.2 mil. To calculate the payback, we need to find the number of years it would take for cash inflows starting year 1 to re-earn $10.2 mil.

Cash flow in Yr + Cashlfow in Yr 2 + Cash Flor in Yr 3 + Cash flow in Yr 4 = $10.2 mil. So payback = 4 years.

This is higher than 2 year paybck required. So, this film should not be made.

NPV is difference between the present value of cash inflows and the present value of cash outflows over a period of time.

NPV = -10.2 + 4.0872 + 1.5674 + 1.4236 + 1.2930 + 1.1744

NPV = - $0.65 mil

Negative NPV implies this project would reduce film maker's net worth and hence should not be made.