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An independent film maker is considering producing a new movie.The initial cost for making this movie will be $20 million today.Once the movie is completed,in one year,the movie will be sold to a major studio for $25 million.Rather than paying for the $20 million investment entirely using its own cash,the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year.Suppose the risk-free rate of interest is 10%.
-Assuming that the film maker issues the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?
A)$1.7 million;Yes
B)$1.7 million;No
C)$2.7 million;Yes
D)$2.7 million;No

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to find the present value of the cash flows from the movie:
PV(Cost of making the movie) = -$20 million
PV(Sale price of the movie) = $25 million / (1+10%) = $22.73 million
PV(Payment to investors) = -$11 million / (1+10%) = -$10 million

NPV = PV(Sale price of the movie) - PV(Cost of making the movie) - PV(Payment to investors)
= $22.73 million - $20 million - $10 million = $2.73 million

Therefore, the NPV for this project is $2.73 million, which is closest to option C, and the filmmaker should make the investment as the NPV is positive.

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