Problem 1:

EPS ACCERTION AND NPV -This chapter demonstrated that the requirement that new projects be accretive to firm EPS sometimes results in accepting negative-NPV projects and rejecting positive-NPV projects. However, under more restrictive circumstances, requiring that new investments be accretive to earnings may be consistent with the NPV criteria. Are the following statements true or false? Defend your answers.

If project earnings are expected to grow at the same rate as the firms earnings, an EPS-accretive project is a positive-NPV project.

The earnings-accretive criterion worked for conglomerates in the 1960s because they were able to take over low-P/E stocks that were earnings accretive.

Problem 2:

VC VALUATION AND DEAL STRUCTURING - Chariot.com needs $500,000 in venture capital to bring a new Internet messaging service to market. The firms management has approached Route 128 Ventures; a venture capital firm located in the high-tech startup mecca, known as Route 128, in Boston, Massachusetts, which has expressed an interest in the investment opportunity.

Chariot.coms management made the following EBITDA forecasts for the firm, spanning the next five years:

Year	EBITDA
1	-$175,000
2	75,000
3	300,000
4	650,000
5	1,050,000

Route 128 Ventures believes that the firm will sell for six times EBITDA in the fifth year of its operations and that the firm will have 1.2 million in debt at that time, including $1 million in interest-bearing debt. Finally, Chariot.coms management anticipates having a $200,000 cash balance in five years.

The venture capitalist is considering three ways of structuring the financing:

Straight common stock, where the investor requires an IRR of 45%.

Convertible debt paying 10 % interest. Given the change from common stock to debt, the investor would lower he required IRR to 35%.

Redeemable preferred stock with an 8% dividend rate plus warrants entitling the VC to purchase 40% of the value of the firms equity for $100,00 in five years. In addition to the share of the firms equity, the holder of the redeemable preferred shares will receive 8% dividends for each of the next five years, plus the face value of the preferred stock in year 5.

Based on the offering terms for the first alternative (common stock), what fraction of the firms shares will it have to give up to get the requisite financing?

If the convertible debt alternative is chosen, what fraction of the firms ownership must be given up?

What rate of return will the firm have to pay for the new funds if the redeemable preferred stock alternative is chosen?

Which alternative would you prefer if you were the management of Chariot.com? Why?