12 Pages Posted: 21 Oct 2008
The cofounder of Compass Records, a small, independent music-recording company, must decide whether to "produce and own" the next album of an up-and-coming folk musician or simply "license" her finished recording. This case presents information sufficient to build cash-flow forecasts for either investment alternative. Discounted cash flow (DCF) analysis reveals that licensing will be the more attractive alternative unless the student assesses the value of the options for follow-on albums included in the "produce-and-own" contract.
Still bleary-eyed after an all-night drive from North Carolina, Alison Brown sat in the office below her recording studio near Nashville's famed “Music Row.” It was late June 2005, and she had a moment to reflect on Compass Records, the artist-run record company that she and her husband, Garry West, had founded 10 years ago. The past few years had brought them great success, but managing the daily myriad decisions for the business remained a challenge. Foremost in her mind was whether to offer a recording contract to a talented new folk musician, Adair Roscommon, whose demo CD she was now listening to in her office.
Compass Records' tenth anniversary was a major milestone in the intense and unforgiving music business. With a roster of well-known and successful artists under contract, Compass had carved out a niche as an established player in the folk and roots musical genres. But unlike executives at the major record companies who typically had large budgets, every decision made by Brown and West regarding new musicians could have a major impact on their business. Compass could scarcely afford to squander resources on an artist in whom Brown and her husband did not believe strongly.
Brown was an acclaimed folk musician about whom the entertainment industry magazine Billboard once wrote: “In Brown's hands, the banjo is capable of fluid musical phrases of boundless beauty.” Brown's assessment of another folk musician's artistic merit, therefore, had tremendous value, and she liked Adair Roscommon's work. Brown was also a former investment banker with an MBA who clearly understood Roscommon's potential as an investment for Compass. Intuitively, Brown grasped the implications of adding a risky asset, such as a new musician, to Compass Records' growing portfolio.
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Keywords: discounted cash flow DCF capital investment, sensitivity analysis, real options
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