Question

Down On Our Luck Studios has spent \(\$ 100\) million producing an awful film, \(A\) Depressing Story About a Miserable Person. If the studio releases the film, the most cost-effective marketing plan would cost an additional \(\$ 5\) million, bringing the total amount spent to \(\$ 105\) million. Box office sales under this plan are predicted to be \(\$ 12\) million, which would be split evenly between the theaters and the studio. Additional studio revenue from video and DVD sales would be about \(\$ 2\) million. Should the studio release the film? If no, briefly explain why not. If yes, explain how it could make sense to release a film that cost \(\$ 105\) million but earns only \(\$ 12\) million.

Short answer

It is not advisable for the studio to release the film, because the expected income (\$8 million) is significantly less than the total cost (\$105 million) of production and marketing.

Step-by-step solution

Calculate the total costs of the film production and marketing

The total costs include the production cost of \$100 million and marketing cost of \$5 million. So, the total cost = \$100 million + \$5 million = \$105 million.

Compute the total expected income

The expected income sources are from box office and DVD sales. However, for box office sales, the studio will only get half, which is \$12 million / 2 = \$6 million. The income from DVD sales is \$2 million. So, the total expected income = \$6 million + \$2 million = \$8 million.

Make a decision based on the results from Steps 1 and 2

Compare the total cost (\$105 million) with the total expected income (\$8 million). Since the cost is much higher than the income, it indicates a loss for the studio if it releases the film now. Hence, it's not advisable to release the film.

Key concepts

Marginal Cost

In the given scenario, understanding marginal cost is crucial. Marginal cost refers to the additional cost incurred by producing one more unit of a good or service. For Down On Our Luck Studios, the marginal cost is the marketing expenditure of \(\\( 5\) million. Although the film production has already cost \(\\) 100\) million, this amount is a sunk cost. A sunk cost is an expense that has already been incurred and cannot be recovered. Hence, it should not influence future economic decisions.
If the studio decides to release the film, the \(\$ 5\) million marketing cost is the only relevant cost for analysis. This is because it represents the new or marginal cost that adds to the pre-existing expenses. Understanding this concept assists in making informed decisions, as it highlights costs that actually impact future profitability.

Opportunity Cost

Opportunity cost is the value of the next best alternative foregone. When Down On Our Luck Studios is considering releasing "A Depressing Story About a Miserable Person," they need to weigh what they might lose in terms of alternate uses of their resources.
For instance:

• The decision to spend \(\$ 5\) million more on marketing could mean not investing in another potentially successful project.
• Choosing to release the film when it predicts a loss, the studio might miss out on the potential opportunity to cut their losses and invest elsewhere for better returns.

Thus, opportunity cost encourages us to contemplate trade-offs in the decision-making process. Here, the opportunity cost helps the studio evaluate whether the additional expenditure aligns with maximizing profit.

Decision-Making Process

Effective decision-making balances various economic principles, and Down On Our Luck Studios faces a critical decision on whether to release their film. The decision-making process involves evaluating available alternatives by considering potential benefits and costs.
Some vital factors in this process include:

• Assessing expected revenues against total costs, where the studio's projected income of \(\\( 8\) million does not recover the total cost of \(\\) 105\) million.
• Ensuring that decisions remain uninfluenced by sunk costs, like the \(\$ 100\) million already spent on production.
• Utilizing tools such as break-even analysis to identify if and when the film could potentially meet its costs.

Ultimately, given the substantial projected loss and the principles of marginal cost and opportunity cost, the studio's decision not to release the film aligns with minimizing unnecessary financial risks.