Entrepreneurial Decision Making

James Jones is an entrepreneur and founder of Tasty Cakes Bakery. During the last year, Tasty Cakes generated $40,000 in operating cash flows, paid $10,000 in capital expenditures (as it does almost every year), and paid $5,000 in dividends. Jones is interested in significantly expanding this year. To do so, he needs to spend $100,000 on equipment in addition to his normal capital expenditures. He believes that if he buys the equipment, his operating cash flows will surely increase by 25% and possibly could double. He has spoken with the bank, which has offered the following two installment note options: Option 1 is a two-year, 5% $100,000 installment note; and Option 2 is a six-year, 10% $100,000 installment note.

Discuss Tasty Cake's free cash flow. Identify the advantages and disadvantages of each option and recommend which option James should pursue.