Question

Suppose that Universal is considering one more Harry Potter 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 -$40.00 million if you only look at ticket sales in the theater. However, they also believe that the movie will create sales of $70.00 million per year in merchandise. The merchandise sales will decline each year by 20.00% in perpetuity. Let’s assume that after-tax operating margin on these sales is 20.00%, and that Universal has a cost of capital at 10.00%. 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 1

After tax operating margin = Sales * 20% = $70 Million * 20% = $14 Million

Present Value of Sale of Merchandise = After Tax Operating margin * (1 + Growth) / (Cost of Capital - Growth)

Present Value of Sale of Merchandise = $14 Million * (1 - 0.20) / (10% + 20%)

Present Value of Sale of Merchandise = $11.20 M / 30%

Present Value of Sale of Merchandise = $37.33 Million

Net NPV = Current NPV + Present Value of Sale of Merchandise

Net NPV = -$40 M + $37.33 Million

Net NPV for creating the movie= -$2.67 Million

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