Question

General This case study is from the Corporate Finance book, chapter 8 in the eBook (pg. 653 in the hard copy, page 261 in eBook). The case study will require you to perform a financial analysis and make some capital investment decisions for Bethesda Mining Company. You will need to prepare various operating cash flows in order to perform your analysis and make a recommendation. The case study is also stated below. Please complete the case study using the excel template found in Engage. As a reminder, please show all of your work! You cannot receive partial credit if you do not show your work. This means that you should use formulas and link to cells whenever possible instead of typing in numbers. This reduces the risk of input errors and it also makes it easier for me to follow your work and thought process.

Case Study:

Bethesda Mining Company is a midsized coal mining company with 20 mines located in Ohio, Pennsylvania, West Virginia, and Kentucky. The company operates deep mines as well as strip mines. Most of the coal mined is sold under contract, with excess production sold on the spot market.

The coal mining industry, especially high-sulfur coal operations such as Bethesda, has been hard-hit by environmental regulations. Recently, however, a combination of increased demand for coal and new pollution reduction technologies has led to an improved market demand for high-sulfur coal. Bethesda has just been approached by Mid-Ohio Electric Company with a request to supply coal for its electric generators for the next four years. Bethesda Mining does not have enough excess capacity at its existing mines to guarantee the contract. The company is considering opening a str?p mine in Ohio on 5,000 acres of land purchased 10 years ago for $5.4 million. Based on a recent appraisal, the company feels it could receive $7.3 million on an after-tax basis if it sold the land today.

Strip mining is a process where the layers of topsoil above a coal vein are removed and the exposed coal is removed. Some time ago, the company would simply remove the cool and leave the land in an unusable condition. Changes in mining regulations now force a company to reclaim the land; that is, when the mining is completed, the land must be restored to near its original condition. The land can then be used for other purposes. As they are currently operating at full capacity, Bethesda will need to purchase additional equipment, which will cost $43 million. The equipment will be depreciated on a seven-year MACRS schedule. The contract only runs for four years. At that time the coal from the site will be entirely mined. The company feels that the equipment can be sold for 60 percent of its initial purchase price. However, Bethesda plans to open another strip mine at that time and will use the equipment at the new mine.

The contract calls for the delivery of 500,000 tons of coal per year at a price of $60 per ton. Bethesda Mining feels that coal production will be 750,000 tons, 810,000 tons, 830,000 tons, and 720,000 tons, respectively, over the next four years. The excess production will be sold in the spot market at an average of $48 per ton, Variable costs amount to $21 per ton and fixed costs are $3.7 million per year. The mine will require a net working capital investment of 5 percent of sales. The net working capital (“NWC") will be built up in the year prior to the sales.

Bethesda will be responsible for reclaiming the land at termination of the mining. This will occur in Year 5 The company uses an outside company for reclamation of all the company's strip mines. It is estimated the cost of reclamation will be $3.9 million. After the land is reclaimed, the company plans to donate the land to the state for use as a public park and recreation area as a condition to receive the necessary mining permits. This will occur in Year 5 and result in a charitable expense deduction of $7.3 million. Bethesda loss in any year will result in a tax credit. faces a 38 percent tax rate and has a 12 percent required return on new strip mine projects. Assume a loss in any year will result in a tax credit

You have been approached by the president of the company with a request to analyze the project. Calculate the payback period, profitability index, net present value, and internal rate of return for the new strip mine. Should Bethesda Mining take the contract and open the mine?

Required:

1. To analyze this project, we must calculate the incremental cash flows generated by the project. Since net working capital is built up ahead of sales, the initial cash flow depends in part on this Prepare the sales forecast in tab 1 of the excel workbook cash outflow. Therefore you need to begin your analysis by calculating your sales forecast.

2. Calculate the initial cash outflow for this project; use tab 1 to calculate your answer.

3. Use tab 2 in the excel workbook to calculate your operating cash flows for this project for years 1 through 6.

4. You will also need to calculate the net working capital cash flow each year, and the cash flow for the sale of the equipment. Calculate these amounts for this project.

5. Finally, using the net cash flows calculated above (operating cash flow, net working capital and after-tax salvage value), calculate the following for this project:

a. Payback Period

b. Profitability Index

c.IRR

d. NPV

e. recommendation (why should they accept or reject?) Explain your answer

Format grading will be required to use the Case Study Template. The template is an excel spreadsheet. Please show all your work

Answer 1

	Calculation of initial investment required(in million)
Sr No	Particulars					Amount
1	Opportunity cost of land used					7.3
2	Equipment cost					43
3	Net working capital (5% of year 1 sales)					2.1
4	Total initial investment					52.4
	Incremental cashflows from Project
Sr No	Particulars	Year 1		Year 2		Year 3		Year 4
1	Contract coal delivery	30000000		30000000		30000000		30000000
2	Excess Coal sales	12000000		14880000		15840000		10560000
3	Total revenues (1+2)	42000000		44880000		45840000		40560000
4	Variable costs	15750000		17010000		17430000		15120000
5	Fixed Costs	3700000		3700000		3700000		3700000
6	MACRS depreciation	6144700		10530700		7520700		5370700
7	Profit before tax (3-4-5-6)	16405300		13639300		17189300		16369300
8	Profit after tax (7*0.62)	10171286		8456366		10657366		10148966
9	Cashflows (8+6)	16315986		18987066		18178066		15519666
	Discounted cashflows	14567845		15136372.8		12938788		9863028
	Total discounted cashflows	52.50603405
	Terminal Cashflows from project in year 5 (in millions)
Sr No	Particulars						Amount
1	Land reclamation cost						-3.9
2	Charitable expenses tax deduction (7.3million*38%)						2.774
3	Salvage value from equipment						21.09
4	Net terminal inflow						19.964
	Salvage value of equipment
Sr No	Particulars						Amount
1	Book value of equipment (43million - 29.57 million)						13.43
2	Sale price of equipment ( 43*0.60)						25.8
3	Tax on capital gains (25.8-13.43)*0.38						4.7006
4	Net Salvage value						21.0994
	Calculation of NPV
Sr No	Particulars						Amount
1	Initial Investment						-52.4
2	Cashflow from project						52.51
3	Discounted salvage value						11.32
4	Net present value						11.43

Since the project has positive NPV hence the project should be accepted.

Internal Rate of return of the project = 11.61%

Profitability Index= 1 + NPV/Initial Investment

= 1+ 0.2181

= 1.2181

Calculation of payback period = 3.99 years

The project should be accepted .

Since the excel template was not found hence the answer is presented in word format.