The Sequel to Chance Encounters

Abstract

Movie-industry analyst David Fitzhugh must estimate the value of the sequel rights associated with Chance Encounters, a soon-to-be-produced movie. The producers intend to use the cash from the sale of the sequel rights to help fund production of the original movie. With the purchase of the sequel rights, the client fully intends to produce a sequel--should the original movie prove successful.

Excerpt

UVA-QA-0831

Feb. 13, 2015

The Sequel to Chance Encounters

In April 2003, David Fitzhugh, a respected movie-industry analyst, was hired to evaluate an unusual business idea—the purchasing of the sequel rights associated with a soon-to-be-produced movie. About six months earlier, Warmer Brothers Studios had approached Fitzhugh's client (a very successful independent-movie producer) with a proposal to sell him the exclusive rights to produce a sequel to Chance Encounters, Warmer Brothers' newest movie. A string of poorly performing movies had left Warmer Brothers badly in need of cash to help defray the estimated $ 25 million cost of making Chance Encounters, and they had come up with the idea of selling the sequel rights. In preparation for the upcoming negotiation, Fitzhugh's client asked him to perform a thorough “data-driven” valuation of the exclusive rights to produce a sequel.

The Basics of the Movie Business

Movies went through three stages to reach the public: production, distribution, and exhibition. Production was the actual making of the movie. The total cost for this stage was called negative cost: the cost to produce the master negative of the movie. Typically, the largest components of negative cost were salaries of the actors and director, set design and construction, and transportation. On average, production of a movie took about a year, at a negative cost of around $ 30 million.

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Keywords: negative cost, hurdle rate, influence diagram, decision making, decision analysis, options thinking, options pricing, model, models, simulation, modeling, probability, forecasting