Final answer:
The payback period for the movie investment is three years, after which the initial $10 million investment is fully recovered. The project would not meet the requirement if a two-year payback period is mandatory. The Net Present Value should be calculated to consider the cost of capital at 10% to assess profitability.
Step-by-step explanation:
The payback period of an investment is the duration needed to recover the initial outlay through the returns it generates. To calculate the payback period for a movie costing $10 million to produce, with expected returns of $5 million in the first year post-release and $2 million for the subsequent four years, we outline the cash flows:
- Year 0 (initial investment): -$10 million
- Year 1 (release year): +$5 million
- Years 2 to 5 (post-release): +$2 million per year
By summing the cash flows, we find that the payback period is in year three. Since the expected returns in the second year post-release will be $2 million, by the end of this year, the total returns will be $7 million, which does not cover the initial $10 million investment. Therefore, the full investment is recovered after the third year.
If the cut-off period for payback is two years, the movie project would not be approved since the full investment is not recovered within this timeframe. Additionally, to determine if the movie has positive Net Present Value (NPV), we must discount future cash flows at the cost of capital, which is 10%. If after discounting the cash flows, the NPV is positive, it means that the movie is expected to generate more than the cost of the capital invested even after considering the time value of money.