Are You Considering Making A Movie? The Movie Is Expected To

You Are Considering Making A Movie The Movie Is Expected To Cost 10

You are considering making a movie. The movie is expected to cost $10 million upfront and take a year to make. After that, it is expected to make $5 million when it is released in one year and $2 million per year 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%?

You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10 million. Investment A will generate $2 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $1.5 million at the end of the first year and its revenues will grow at 2% per year for every year after that.

a. Which investment has the higher IRR?

b. Which investment has the higher NPV when the cost of capital is 7%?

c. In this case, for what values of the cost of capital does picking the higher IRR give the correct answer as to which investment is the best opportunity?

Forecasting Earnings 1.

Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats. The firm expects that sales of the new pizza will be $20 million per year. While many of these sales will be to new customers, Pisa Pizza estimates that 40% will come from customers who switch to the new, healthier pizza instead of buying the original version.

a. Assume customers will spend the same amount on either version. What level of incremental sales is associated with introducing the new pizza?

b. Suppose that 50% of the customers who will switch from Pisa Pizza’s original pizza to its healthier pizza will switch to another brand if Pisa Pizza does not introduce a healthier pizza. What level of incremental sales is associated with introducing the new pizza in this case?

Paper For Above instruction

Investments, NPV, IRR, and Forecasting Earnings Analysis

The considerations involved in evaluating a potential movie investment, comparing mutually exclusive investment opportunities, and forecasting sales for a new product involve complex financial analysis techniques. These include calculating payback periods, net present value (NPV), internal rate of return (IRR), and assessing incremental sales. This paper explores each scenario, applying fundamental principles of capital budgeting and financial decision-making to provide clear recommendations based on quantitative analysis.

Evaluating the Movie Investment

The first scenario involves assessing a film project with an initial investment of $10 million, a production timeline of one year, and projected financial returns over subsequent years. The cash flows include an initial outlay, a release year revenue of $5 million, and ongoing revenues of $2 million per year for the next four years. The goal is to determine the payback period and evaluate if the project aligns with a two-year payback requirement, as well as whether it has a positive NPV at a 10% discount rate.

The payback period measures how long it takes for cumulative cash inflows to recover the initial investment. Calculating cumulatively: after the first year, the revenue of $5 million still leaves the initial $10 million unrecovered; after the second year, the sum of cash inflows is $7 million, and after the third year, $9 million — still below initial investment; after the fourth year, total inflows reach $11 million, surpassing initial outlay. Therefore, the payback occurs slightly in the fourth year, roughly between three and four years, indicating a payback period of approximately 3.5 years. Since this exceeds the two-year requirement, the project would not be pursued under this criterion.

To evaluate the NPV at a 10% discount rate, the present value of future cash flows is calculated: the $5 million in Year 1, and the $2 million annually from Years 2 through 5 are discounted back at 10%. The discounted cash flows sum to less than $10 million, resulting in a negative NPV. Consequently, based on NPV analysis, the project is not financially viable at this discount rate.

Comparing Two Investment Opportunities

The second scenario involves two mutually exclusive projects requiring a $10 million initial investment. Investment A offers perpetual annual cash flows of $2 million, while Investment B provides an initial $1.5 million in Year 1, with cash flows growing at 2% annually thereafter. The analysis aims to determine which investment has the higher IRR, which has a higher NPV at a 7% discount rate, and the conditions under which IRR ranking aligns with optimal choice.

Higher IRR Investment

The IRR is the discount rate at which NPV equals zero. For Investment A, being a perpetuity, the IRR is straightforward: IRR = Annual Cash Flow / Initial Investment = $2 million / $10 million = 20%. For Investment B, the IRR involves solving a more complex equation due to growth, resulting in an IRR slightly above 15%. Since 20% > 15%, Investment A has the higher IRR.

Higher NPV at 7% Cost of Capital

The NPV of Investment A is calculated as the present value of a perpetuity: PV = $2 million / 0.07 ≈ $28.57 million, which exceeds the initial investment, yielding an NPV ≈ $18.57 million. For Investment B, NPV is computed by summing the discounted cash flows, accounting for the growth, resulting in a lower NPV compared to Investment A at 7%, likely around $2 million in positive value. Therefore, at 7%, Investment A has the higher NPV.

Condition for Choosing Based on IRR

Choosing the project with the higher IRR provides correct decision-making when the cost of capital is less than the IRR of the project with the higher IRR and when the project’s cash flows are conventional (initial outflow followed by inflows). In this case, since Investment A’s IRR of 20% exceeds that of B, the IRR rule is accurate for discount rates below 20%. When the cost of capital surpasses the IRR of the lower-ranked project, the IRR rule becomes unreliable due to potential multiple IRRs or non-linear payoffs.

Forecasting Earnings and Assessing Incremental Sales for Pisa Pizza

The case involves estimating incremental sales resulting from introducing a healthier pizza variant. The product’s expected annual sales are $20 million, with 40% attributed to customers switching from the original product. The analysis considers the direct incremental sales and how competitive responses might influence these figures.

Incremental Sales Without Competitor Response

Assuming customers spend the same amount on each version, the 40% switching from existing customers to the new product implies that the economic benefit is the additional sales generated by attracting these customers. Thus, the incremental sales are calculated as 40% of total projected sales: 0.40 x $20 million = $8 million annually.

Incremental Sales Accounting for Customer Switching to Other Brands

If 50% of the customers who switch to the new product would have otherwise purchased from competitors, then the net incremental sales for Pisa Pizza are reduced by these lost potential customers. Therefore, the net incremental sales are: (40% of $20 million) minus those customers who would have switched to other brands, which is 50% of the switched customers or 0.50 x 40% = 20% of total sales, equating to 0.20 x $20 million = $4 million. Net incremental sales in this scenario are $8 million - $4 million = $4 million annually.

Conclusion

Evaluating investment opportunities and forecasting sales requires quantitative analysis techniques that incorporate cash flow timing, growth rates, and customer behavior. In the initial movie project, the payback period and NPV suggest an assessment against predefined thresholds, leading to a negative investment decision. For the competing projects, IRR and NPV comparisons reveal that investment A is more attractive at the given discount rates, yet the decision depends on the cost of capital. In the product launch scenario, understanding customer switching behaviors significantly affects the estimated incremental sales, guiding strategic pricing and marketing decisions. These analyses exemplify key principles in capital budgeting essential for informed managerial decision-making.

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