Espasso is negotiating for Tornado 2, a sequel to its mega-blockbuster Tornado. This negotiation is proving more difficult than for the original movie. The budgeted production cost (excluding payments to the director Vieira and the stars Moura and Rebello) for Tornado 2 is €21 million. The agent negotiating for Vieira, Moura and Rebello proposes either of two contracts:
• Contract A: Fixed-salary component of €15 million for Vieira, Moura and Rebello (combined) with no residual interest in the revenues from Tornado 2.
• Contract B: Fixed-salary component of €3 million for Vieira, Moura and Rebello (combined) plus a residual of 15% of the revenues Espasso receives from Tornado 2.
Artes e Media will market Tornado 2. It agrees to invest a minimum of €10 million of its own money. Because of its major role in the success of Tornado, Artes e Media will now be paid 25% of the revenues Espasso receives from the total box-office receipts. Espasso receives 62.5% of the total box-office receipts (out of which comes the 25% payment to Artes e Media).
Required
1 What is the breakeven point for Espasso expressed in terms of:
a. Revenues received by that company
b. Total box-office receipts for Tornado 2 for contracts A and B? Explain the difference between the breakeven points for contracts A and B.
2. Assume Tornado 2 achieves the same €300 million in box-office revenues as Tornado. What is the operating income to Espasso from Tornado 2 if it accepts contract B? Comment on the difference in operating income between the two films.