Blockbusters Incorporated, a leading producer of movies, is currently negotiating with Liam Goodlooking, the biggest box-office attraction in the movie industry, to star in an adventure film. For a starring role, Liam normally receives a salary of $20,000,000 plus 5% of the receipts to the producer. (The producer normally receives 40% of the total paid admissions wherever the movie is shown.) However, Liam is quite optimistic about the prospects of the film and has expressed some interests in a special contract that would give him only 25% of his normal salary but increase his portion of the receipts to the producer to 20%. Other than Goodlooking’s pay, costs of producing the picture are expected to be $45,000,000.

Both the producing company and prospective star have given further thought to the contract terms and concluded that some provision probably should be made for revenues to be earned from contracts authorizing showings of the movie on television. After lengthy negotiations, Goodlooking’s agent proposed the following terms:

(a) a payment of $10,000,000, plus

(b) 15% of the receipts to the producer from theatre admissions, plus

(c) 10% of the revenues from sales of television rights.

Blockbuster’s negotiating team leaves the negotiations to study the potential effect of the new order.

A study of past productions indicates that the producer can expect revenues from sales of television rights to be approximately one-eighth (12.5%) of producer’s revenues from theatre admissions. Blockbusters’ president is pleased with the opportunity to lower the fixed-payment part of the contract but is concerned about the magnitude of the two off-the-top percentages.

The president of Blockbusters Incorporated has reviewed the preliminary analysis of the two contract alternatives and wishes to give further consideration to the arrangement with Goodlooking.

Goodlooking's agent also having second thoughts about the alternatives and is wondering what is best for his client.

Required:

Answer the following questions, calling the alternative compensation schemes N (for the normal Contract) and S (for the special contract).

1.  If total paid admissions in theaters are expected to be $200,000,000, what will be the income to the producer under compensation scheme N and S?

2. At what level of receipts to the producer would Goodlooking earn the same total income under compensation schemes N and S?

3. At what level of receipts to the producer will Blockbuster break even under the new contract proposal?

4. Considering the additional information about the sale of television rights, at what level of receipts to the producer will Blockbusters break even under Goodlooking’s normal contract terms ($20,000,000 plus 5% of the producer’s receipts)?

5. Assume that, because of Blockbusters’ delay in accepting the contract offer, Goodlooking’s agent decides that his client should also receive a percentage of the revenues Blockbusters will derive from the sale of screening rights in foreign countries, revenues which typically amount to 20% of domestic receipts. If the agent proposes a 5% cut of those revenues for Goodlooking, what is the break-even point for Blockbusters Incorporated?

6. If total paid admissions are expected to be between $180 and $200 million, which compensation scheme is best for (a) Blockbusters and (b) Goodlooking?

7. If total paid admissions are expected to be about $300 million, which scheme is better for (a) Blockbusters and (b) Goodlooking?