"check in the Extensions folder in the System Folder on the hard drive. Look for either or both of these files in there
- Macintosh Drag and Drop
- DragLib
If found, throw them away and then try a normal restart."
The problem will be that you cannot boot at the moment. So try to boot without Systme Extensions (Shift Keys). If it doesn't work you will need to boot from an external source, be it an network device, or anything else (could the imac already boot from USB?). Last idea is that you have to get out the disc and mount it at another computer.
For the records, there was an Apple KowledgeBase article for this particular problem:
http://www.info.apple.com/kbnum/n31297 but archive is not working at the moment (at least form my place). The background is: "both of the files DragLib and Macintosh Drag & Drop can be installed by older software. Those extensions are not compatible with OS 8.5 and higher, although OS 9.1 and higher have been programmed to ignore them."