Question

1. Avril Skatergirl is trying to decide which recording contract she should accept and wishes it wasn’t so complicated that she can’t keep her head above water amidst all the numbers.  Getting it right could be worth more than just a nickel back. Her opportunity cost is 5% p.a.

1. I’m With You Productions Inc. offers a payment of $2 million now on her next album plus 50% royalty on gross sales of $5 million for two years, with the royalties paid at the end of years 2 and 3.  It will launch a line of Skatergirl branded clothing and other gear, paying $100,000  royalty on gross sales for five years, with the first payment end of year 1.  How much is this contract worth?
2. Nobody’s Home Ltd. Offers no advances, but 70% gross royalty on the next album (same sales pattern) and a guaranteed starring role in a film about a girl who overcomes Lyme Disease to play right wing for Canada’s National Women’s Hockey Team.  She would be paid $3 million in two years time for the film role.  How much is this contract worth?

Answer 1

a. The cash flows are as below. Value of the contract= $6,860,115.36

I’m With You Productions Inc
Year	Album Sales	Clothing sales	Net Cash flow
0	2000000		2000000
1		100000	100000
2	2500000	100000	2600000
3	2500000	100000	2600000
4		100000	100000
5		100000	100000
		NPV	$6,860,115.36

b) Value of the contract= $8,919,123.20

Nobody’s Home Ltd.
Year	Album Sales	Movie contract	Net Cash flow
0			0
1			0
2	3500000	3000000	6500000
3	3500000		3500000
4			0
5			0
		NPV	$8,919,123.20

Workings