United Studios holds the movie rights for a national best-seller, and as part of these rights also has the option to produce a sequel based on the same book. The studio is now in the process of developing the production schedule. It believes that shooting both movies simultaneously would allow significant cost savings, and both movies could be produced for a total budget of

$ 525 million. If instead the movies are produced sequentially, the total expected cost will rise to

$ 575 million. On the other hand, by waiting to produce the second movie until after the first movie is released, the studio will have much better information regarding the likely prospects for the sequel. Let's see how we can use a decision tree to analyze this situation. In the case in which the movies are produced simultaneously, the studio forecasts it will earn a total of

$ 645 million from both movies, for a net profit of $ 120 million.

While United's expected earnings imply that the movies are worth producing, there is significant uncertainty regarding the actual outcome. In fact, the expected total revenue of

$ 645 million for both movies reflects two alternative outcomes. Based on the popularity of the book, United believes there is a

50 % chance the first movie will be a blockbuster success, in which case the studio expects it will earn

$ 495 million from it alone, and another $ 395million for the sequel. If instead the first film is just a moderate hit, it will only bring in $ 305 million, and the sequel will only be expected to earn $ 105

million. Suppose United has the rights to produce the first film, but has not yet purchased the sequel rights.

a. How much are the sequel rights worth to United?

b. Suppose United can purchase the sequel rights now for $ 25 million. Alternatively, United can pay $ 8

million now for the option to buy the sequel rights for $ 25

million in the future. Which should it choose?