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Select and explain a Financing Method by a VC for Phoenix Corp

See attached file.

Phoenix Corp. needs $500,000 to finance its growth and it approached a venture capitalist (VC) firm to fund its future growth in business. The VC may agree to supply the funds if terms are acceptable. It asked Phoenix to provide an estimate of EBIT for the next eight years which are given below:

1 $-200,000
2 150,000
3 400,000
4 450,000
5 800,000
6 950,000
7 1,100,000
8 1,500,000

If the VC agrees to invest in Phoenix, it plans to exit after eight years at which time it expects that the company's value would be eight times of its year 8 EBIT. Based on the financial analysis and future forecasts, VC also estimates that Phoenix will have $1,500,000 of debt outstanding including $1,250,000 interest-bearing debt at the end of eight years. It will also have $250,000 of cash at the end of eight years.

The VC is considering three different ways of structuring the financing:

1. Straight common stock where VC will not receive any dividend for first four years and will receive 20% of NOPAT as dividend for the remaining four years. Tax rate for Phoenix is 40%. In addition, VC will receive a 45% ownership of the company's equity at the end of eight years.

2. Convertible debt with 10% coupon rate. The debt will be converted for 30% ownership of the equity of Phoenix at the end of eight years.

3. Redeemable preferred stock with 7.5% dividend plus warrants for 35% of the equity for an exercise price of $150,000. (Note: Redeemable means that the preferred stock can be redeemed for the face value at the end of eight years.)

Which financing method should be selected by Phoenix Corp? Explain your answer.


Solution Summary

The expert selects and explains a financing method by a VC for Phoenix Corp.