Down On Our Luck Studios has spent 100 million dollar n...

Down On Our Luck Studios has spent 100 million dollar n producing an awful film, $A$ Depressing Story About a Miserable Person. If the studio releases the film, the most cost-effective marketing plan would cost an additional 5 million dollar, bringing the total amount spent to 105 million dollar. Box office sales under this plan are predicted to be 12 million dollar, which would be split evenly between the theaters and the studio. Additional studio revenue from video and DVD sales would be about 2 million dollar. Should the studio release the film? If no, briefly explain why not. If yes, explain how it could make sense to release a film that cost $\$ 105$ million but earns only 12 million dollar

Key Concepts

Break-even Analysis

Break-even analysis determines the point at which total revenues equal total costs, meaning no net loss or gain. Even when sunk costs are ignored, it is useful to assess whether the additional spending (for example, on marketing) will at least be covered by the incremental revenue generated. This helps in evaluating if a project is worth continuing, based on whether it can reach a break-even point on additional investments.

Cost-Benefit Analysis

Cost-benefit analysis is an evaluation process that sums up the benefits and subtracts the costs of a particular decision to determine its overall value. When applied to releasing a film, the analysis compares all incremental future costs—such as additional investments in marketing—to all incremental revenues, like a portion of box office receipts and ancillary income. This method provides a rational framework to decide if a project should proceed.

Sunk Cost Fallacy

This concept refers to the mistake of considering money already spent—which cannot be recovered—when making future decisions. Instead of letting prior expenditures cloud judgment, decision-makers should focus on future benefits and costs. In economic and business decision-making, only new or incremental costs and revenues should influence the choice at hand.

Marginal Analysis

Marginal analysis involves comparing the additional (or marginal) benefits and costs of a decision. In scenarios like this, where the production cost is already sunk, the focus should be on the extra marketing expense versus the extra revenue expected from releasing the film. The idea is to decide whether the additional investment will yield a net positive return.

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