explain whether the option to delay the project valuable?
Menlo Ventures offers three different ways of structuring the financing:
1. Straight common stock where the VC will not receive any dividend for the first four years and will receive 20% of NOPAT as a dividend for the remaining four years. The expected tax rate for Pharmaset is 21%. In addition, the VC will receive a 20% ownership of the company’s equity at the end of eight years. In the case of bankruptcy 20% ownership of the company’s equity will apply to the book value immediately
2. Redeemable convertible debt with 10% coupon rate (interest is tax-deductible). The debt will be converted for 15% ownership of the equity of Pharmaset at the end of eight years. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets’ book value, whichever number is lower.
3. Redeemable preferred stock with 7.5% dividend plus warrants for 15% of the equity for an exercise price of $150 M. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets’ book value, whichever number is lower.
Which financing method should be selected by Fosbeck? Should it accept Menlo Ventures offer? Explain your answer.
Frequently Asked Questions/Helpful Hints:
Is it enough to submit Excel file?
No! The deliverable outcome is your written report to the CFO. You use Excel to support your recommendations
Is there a minimum or maximum size of the report?
Although there is no formal minimum size of the report, it has to address all issues raised and provide your analysis and supporting evidence. To complete the thorough analysis required for this assignment you will probably need 3-4 pages. It is also a good idea to add a one-page executive summary to your report.
Similarly, there is no maximum limit for the report, but please avoid adding superfluous information to your report.
How do I set up Crystal Ball simulation?
Hint: use “Yes-No” distribution to create a binary (one or zero) variable indicating project continuation each year. Make revenues and costs dependent values of these binary variables.
How do I explain whether the option to delay the project valuable?
Analyze the costs and benefits of making the capital investment in two steps and delaying the project’s positive cash flows by two years and shortening the revenue stream.
Are preferred dividends tax deductible?
No, unlike coupon payments, preferred dividends are not tax deductible.
How do I decide which financing option is better?
One approach would be to see which option is less costly from Fosbeck’s management point of view.
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