Finally, to further reduce its risk Fosbeck considers keeping acquired Pharmaset as a separate company. In this case Fosbeck will eventually shift its R&D to Pharmaset, which will continue as a viable business even after the initial patent expires. Therefore, we can ignore the probability of a patent becoming obsolete. However, if FDA approval is not received this year, Pharmaset will go bankrupt, in which case its assets will be sold at residual book value. A venture capital (VC) firm Menlo Ventures is willing to provide financing of up to $5 B in acquisition of Pharmaset. If the VC agrees to invest in Pharmaset, it plans to exit after eight years at which time it expects that the companys value would be eight times its year 8 EBIT. Menlo Ventures offers three different ways of structuring the financing: 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 tax rate for Pharmaset is 38%. In addition, the VC will receive a 20% ownership of the companys equity at the end of eight years. 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. 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? Explain your answer.

CoGS ratio	15%
growth	50%
SGA Fosbeck	$2.00
SGA Pharmaset	$3.50
Pharmaset PPE	$3.00
Revenue1	$10.00
Project Life	10 years
Tax rate	38%
R&D	$0.60
Pharmaset probability of approval	40%
probability of obsolescence	5%
WACC	12%
Menlo Venture Investment	$5.00
Valuation multiple	8 x EBIT
Pharmaset If FDA Approved
Year	2017	2018	2019	2020	2021	2022	2023	2024	2025
Revenue
Cost
SGA if acquired
Depreciation (unconditional)
EBIT
Taxes
NOPAT
Terminal Value
Pharmaset Book Value
All Equity Case
Menlo Ventures Share	20%
Dividends 1-4	0%
Dividends 5-8	20%
Fosbeck Incremental Cash Flow (After-Tax)
	2017	2018	2019	2020	2021	2022	2023	2024	2025
If Successful
If Fails
Expected
NPV
IRR
Convertible Debt
Menlo Ventures Share	15%
Coupon Rate	10%
Fosbeck Incremental Cash Flow (After-Tax)
	2017	2018	2019	2020	2021	2022	2023	2024	2025
If Successful
If Fails
Expected
NPV
IRR
Redeemable Preferred
Menlo Ventures Share	15%
Dividend Rate	7.5%
Warrants Price	$0.15
Fosbeck Incremental Cash Flow (After-Tax)
	2017	2018	2019	2020	2021	2022	2023	2024	2025
If Successful
If Fails
Expected
NPV
IRR