Johns Barley Mill is considering adding a new production line to its existing facility. The new production line will increase Johns sales revenue by $1 million/year. Sales of this offering have a gross margin of 70% and the cost of operating the new line is another 50% of sales on an annual basis. The company does not have any excess capital to invest in this project beyond what they acquire through the debt/equity associated with this project.

The new production line will cost $3 million to develop and install. The expected lifetime of this new equipment is 10 years.

The company has the opportunity to finance this purchase through their bank with debt financing at 9% per year over 5 years.

The company can also accept equity financing from an outside investor. They will have to give this new investor 20% ownership in the company in exchange for these funds.

The company currently has a market valuation of $20 million. If it continues to hit its projections, which are extremely conservative based on this investment, the valuation will increase by at least 10%/year in this environment. If they do not make this investment, then the value of the firm will remain constant over the same period of time.

(1) Would equity or debt financing be preferable given the terms presented?

(2) Should John move forward with this investment?