1. What is the basic nature of the problem in this case?

2. What are the cash flows associated with its licensing? What are the cash flows associated with producing and owning the recording?

3. What do the results of the foregoing DCF analysis suggest?

4. Are you uncertain about any of the assumptions? What does a sensitivity analysis of those assumptions reveal? 

5. Are there qualitative issues that we should address, but which are not reflected in the DCF analysis?

6. What should Alison Brown do?

The cofounders of Compass Records, a small, independent music recording company, must decide whether to produce and own the next album of an up-and-coming folk musician, or simply license her finished recording. The case presents information sufficient to build cash flow forecasts for either investment alternative. The task for the students is to build a valuation model for the two capital investment alternatives, whereby they can evaluate the attractiveness of the investment based on net present value (NPV) and the internal rate of return (IRR) of the discounted cash flows (DCF). Further, the student will have the opportunity to interpret those results and to test those measures’ sensitivity to variability in the base case. This case was prepared with the following objectives in mind.

• Apply DCF analysis to an either/or capital investment decision.
• Interpret the NPV and IRR results.
• Exercise a sensitivity analysis to determine the factors that have the most effect on an investment’s potential outcome.