Jitters Coffee is considering expanding its business by investing in a new coffee bean roasting facility. The investment required today (year t = 0) is $5 million. This investment can be depreciated using the straight-line method over the next two years (to a value of zero at the end of year 2). In addition, Jitters will need to increase its net working capital by $0.3 million per year in years 0, 1, and 2, after which point its working capital will stay fixed.
The company expects that it will take a few years before the facility can begin production. Gross profit (revenue − operating cost) is expected to start at $1 million in year t = 3 and grow by 3.5% per year thereafter.
Assume that the CAPM holds. The risk-free rate is 3%, and the market's expected return is 11%. Jitters has no cash or debt, and for now it plans on using all equity financing for this project. Its corporate tax rate is 35%, and assume that its existing business is sufficiently profitable that it can always claim the full depreciation tax credit for the new project.
(a) Estimate Jitters's free cash flows for years 0, 1, 2, and 3.