Pierre, a book broker, is about to sign a contract to buy the rights to a book about twin teenage computer-security sleuths titled Nan and Dan vs. the Monika Worm. His offer to advance $50,000 for the book has been verbally accepted. Pierre plans to immediately turn over his rights to a publisher with whom he has a standing agreement, netting$20,000 for his efforts in searching through hundreds of leads and manuscripts to find this book. The possibility of a sequel to the book has occurred to him (having just read the latest Harry Potter book), so he is considering adding language to the contract giving him rights to a sequel. It is reasonable to assume that the sequel, should it be written, would bring him $75,000 from a publisher, 18 months from now. Determine if it would be attractive to Pierre to add language to the contract that would secure the rights to a sequel involving the same characters, under the following conditions:

a. Pay an additional $10,000 now for a right of first refusal on the first sequel to Nan and Dan vs. the Monika Worm, providing …

b. The exercise price in 2 years is again a $50,000 advance on the sequel. Assume Pierre’s hurdle rate is 10% per year and that the probability of an acceptable sequel in 18 months is 0.6. Suppose you thought you could negotiate a 20% reduction in one, but not both, of the amounts in (a) and (b). Which one should he most like to change? Should Pierre be willing to increase the option offers? To what level?

c. (Extra credit) How would you structure the analysis of an option on a series of Nan and Dan books flowing from the first?