In 2013, Ed intends to invest $1,500,000 in a bowling alley. After two years of operation, he plans to invest an extra $450,000 in the business by opening a restaurant. In 10 years, Ed anticipates selling the business for $3 million. Ed’s cost of capital will be 11%. Ed would like to earn at least a 20% internal rate of return. Ed can also lease a bowling alley that is located in a different city. The yearly cash flow from operations is estimated at $200,000 (net after the lease payment) for the next 10 years. Ed would also like to make 20% on this investment.

1. Is purchasing the bowling alley and restaurant a good investment? To answer this question, calculate the following:

• The net present value by using the cost of capital

• The internal rate of return

Ed predicts that the business will generate the following cash flows:

2. Is leasing the bowling alley a good decision?
3. If Ed can only do one or the other, should he purchase or lease?Why?

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Year Amount -$1,500,000 +200,000 450,000 (restaurant purchase) +250,000 +300,000 +350,000 +400,000 +450,000 +500,000 +525,000 +550,000 +575,000 10 10 (sale of business)