Question

The CEO of Garneau Cinemas is considering making a movie and must decide between a comedy and a thriller—it ​doesn't have the production space to make both. The comedy is expected to cost $25 million up front​ (at t​ = 0). After​ that, it is expected to make 16 million in the first year​ (at t​ = 1) and $44 million in each of the following two years​ (at t​ = 2 and t​ = 3). In the fourth year​ (at t​ = 5), it is expected that the movie can be sold into syndication for ​$22 million with no further cash flows back to Garneau Cinemas. The thriller is expected to cost ​$40 million up front​ (at t​ = 0). After​ that, it is expected to make $20 million in the first year​ (at t​ = 1) and $44 million in each of the following four years​ (at t​ = 2,​ 3, 4, and​ 5). In the sixth year​ (at t​ = 6), it is expected that the movie can be sold into syndication for $30 million with no further cash flows back to Garneau Cinemas. The cost of capital is 11​%,and Garneau usually requires projects to have a payback within four years. Determine each​ project's payback and​ NPV, and advise the CEO what she should do.

a) The payback for the comedy is _____ ​years, and the NPV of the comedy is $_____?

b) The payback for the thriller is _____ ​years, and the NPV of the thriller is $_____?

Answer 1

Note: There seems to be some error in the question as the cash flows for comedy movie are written for fourth year but given at t=5.

Assuming correction that it is for t=4 only, the solution will be as given below:

Solution:

Formulas used:

Thus,

a) The payback of comedy is 1.20 years and the NPV is $71.79 million

b) The payback of thriller is 1.45 years and the NPV is $117.04 million

As the payback of both the options is well within the 4 years requirement of the company, the NPV is the deciding factor. Since Thriller has higher NPV than the comedy, thus the CEO should choose to make Thriller rather than the comedy in this case.