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 -$43.00 million if you only look at ticket sales in the theater. However, they also believe that the movie will create sales of $80.00 million per year in merchandise. The merchandise sales will decline each year by 21.00% in perpetuity. Let’s assume that after-tax operating margin on these sales is 14.00%, and that Disney has a cost of capital at 8.00%. 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

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Year 1	$ Million			Perpetuity	$ Million
Sale of merchandise in Year 1	80.00	A		Sale of merchandise in Year 1	80.00	A
Operating margin	14%	B		Operating margin	14%	B
Operating cash flow for year 1	11.20	C=A*B		Operating cash flow for year 1	11.20	C=A*B
Cost of capital	8%	D		Cost of capital: 8%	0.08
PV factor at 8%	0.93	E		Growth Rate= -21%	(0.21)
Present Value of Operating cash flow	10.37	F=C*E		The present value of the declining perpetuity is	A1 x 1 / (r - g)
				A 1= Operating cash flow for year 1	11.20
				r= Cost of capital: 8%	0.08
				g=Growth Rate= -21%	(0.21)
				The present value of the declining perpetuity is	11.20* 1/(0.08--0.21)
				The present value of the declining perpetuity is	11.20* 1/(0.29)
				The present value of the declining perpetuity is	38.62
				The net NPV for creating the movie	$ Million
				NPV of ticket sales	(43.00)
				The present value of the declining perpetuity is	38.62
				The net NPV for creating the movie	(4.38)