Question

You are currently negotiating a book publishing deal on behalf of your client, K.J. Howling, a writer of moderate repute who specializes in horror stories.

Your client is basically happy with the standard form contract offered by the publisher, Scattered House Press (SHP). There is, however, an important exception. Howling would like to have a clause removed from the contract under which SHP would have automatic rights to publish any sequel, on the same royalty terms as the contract now under negotiation. In response to this request, SHP has replied af rmatively, but only on the condition that Howling be willing to give SHP half the royalties from any sale of movie rights on the rst book. (The current standard form contract would let Howling keep all the movie rights.)

As you discuss this swap of contract terms with Howling, you come to agree on the following: First, none of this matters unless the rst book is a hit, which has a probability of 10%.

Second, if the book is a hit, there will de nitely be a sequel (which Howling has already outlined). If Howling is able to bargain freely on the sequel, she stands to make about $1,000,000 on the new book, but she would only make about $500,000 if she were bound by the current term. (The reason is that, if the rst book is a hit, she will be able to obtain better royalty terms than she can now.)

Third, if the book is a hit, then there is a 20% chance that a year or two later some movie studio will pick Howling’s book as the basis for preparing a movie script. In that event, the movie rights would be worth about $10,000,000.

Advise Howling on whether to accept the proposed swap of contract terms. In preparing your advice, be sure that you do each of the following:

• Write down the decision tree for this problem.

• Solve it. (Be sure brie y to explain your work in some fashion that will communicate to

  Howling how you reached your conclusion.)

  In addition, you should feel free to make any additional comments you think appropriate in advising Howling. (This is not required; if you do add remarks, be brief, e.g., a paragraph or so.)

Answer 1

FIrst of all, weather KJ Howling accepts the new contract or not, she will earn $500,000 from SHP as royalty of her first book.

A) If KJ Howling accepts the new terms, she can earn better royalty ($1,000,000) from her sequel book. However that would happen only if her first book is a hit. The probability of her first book being a hit is 10%

Hence she can earn $1,000,000 * 10% = $100,000

Also if her first book is a hit (chances are 10%) , then there is a 20% probability that her book will be picked for a movie script & she will receive $10,000,000 movie rights. However she will have to share 50% of the same with SHP.

Hence she will earn $10,000,000 * 10% * 20% * 50% = $100,000

Total earnings if she accepts new contract = 500,000 + 100,000 + 100,000 = $700,000

B) If KJ Howling continues with the old terms, SHP will have the rights to publish her sequel book at same terms ie. she will be paid $500,000. However this will happen only if her first book is a hit, the probability of which is 10%

Hence she will earn $500,000 * 10% = $50,000

Also if her first book is a hit (chances are 10%) , then there is a 20% probability that her book will be picked for a movie script & she will receive $10,000,000 movie rights.

Hence she will earn $10,000,000 * 10% * 20% = $200,000

Total earnings if she continues the old contract = 500,000 + 50,000 + 200,000 = $750,000

Conclusion: Since income expected to be earned is more if we continue with the same contract terms, it is adviced to KJ Howling to not accept the proposed swap of contract.