Question

You are considering making a movie. The movie is expected to cost $ 10.5million upfront and take a year to produce. After​ that, it is expected to make $ 4.5 million in the year it is released and $ 1.9 million 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 10.6%

Answer 1

Pay back period is calculated as follows:

Year	Opening Balance	CF	Closing Balance
1	$10.50	$4.50	$6.00
2	$6.00	$1.90	$4.10
3	$4.10	$1.90	$2.20
4	$2.20	$1.90	$0.30
5	$0.30	$1.90	$-1.60

• Opening balance of year 1= Cost
• Opening balance = previous year's closing balance for all years after year 1
• Closing balance = Opening balance - CF
• As we can see that the closing balance at the end of year 4 is 0.30 and the CF for year 5 is 1.90 so the 0.30 is recovered in 0.30/1.90 = 0.16 portion of the year 5
• Payback period is 4+0.16 = 4.16 years

As the payback period is greater than 2 years, so the project should not be calculated.

NPV is calculated as follows:

Year	CF	Discount Factor	Discounted CF
0	$-10.50	1/(1+0.106)^0=	1	1*-10.5=	$ -10.50
1	$    4.50	1/(1+0.106)^1=	0.904159132	0.904159132007233*4.5=	$     4.07
2	$    1.90	1/(1+0.106)^2=	0.817503736	0.817503735992073*1.9=	$     1.55
3	$    1.90	1/(1+0.106)^3=	0.739153468	0.739153468347263*1.9=	$     1.40
4	$    1.90	1/(1+0.106)^4=	0.668312358	0.668312358360998*1.9=	$     1.27
5	$    1.90	1/(1+0.106)^5=	0.604260722	0.604260721845386*1.9=	$     1.15
				NPV = Sum of all Discounted CF	$   -1.06

NPV is not positive so the project should not be accepted.