Question

Bethesda Mining 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 strip mine in Ohio on 5,000 acres of land

purchased 10 years ago for $4 million. Based on a recent appraisal, the company feels it

could receive $6.5 million on an aftertax 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 coal 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. Because it is currently

operating at full capacity, Bethesda will need to purchase additional necessary equipment,

which will cost $95 million. The equipment will be depreciated on a seven-year MACRS

schedule. The contract runs for only 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 in four years. 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 $86 per ton.

Bethesda Mining feels that coal production will be 620,000 tons, 680,000 tons, 730,000 tons,

and 590,000 tons, respectively, over the next four years. The excess production will be sold in

the spot market at an average of $77 per ton. Variable costs amount to $31 per ton, and fixed

costs are $4,100,000 per year. The mine will require a net working capital investment of 5

percent of sales. The 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 $2.7 million. In order to get the

necessary permits for the strip mine, the company agreed to donate the land after reclamation

to the state for use as a public park and recreation area. This will occur in Year 6 and result

in a charitable expense deduction of $6 million. Bethesda faces a 38 percent tax rate and has

a 12 percent required return on new strip mine projects. Assume that 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?

Answer 1

Depreciation :

	Y0	1	2	3	4
Net Capital Costs	-
Depreciation Expense		1,357,550.00	2,326,550.00	1,661,550.00	1,186,550.00
Depreciation - 5 Year (MACRS)		14.29%	24.49%	17.49%	12.49%

value of machine after 4 the year = $ 29,678,00

Profit on sell of equipment = 95,000,000 * 60% - $ 29,678,000 = $ 27,322,000.

Net Cash Flow
	Y0	1	2	3	4	5	6	Totals
Net Capital Costs
New equipment cost	$      95,000,000
Land cost	$        6,500,000
Working capital for 1 yr sales(@5%)	$        2,612,000
		$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                       -
Total Capital	$   (104,112,000)	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                       -
Operating and Maintenance Costs
variable cost ($31 per ton)		$    19,220,000	$    21,080,000	$    22,630,000	$    18,290,000	$                 -	$                 -	$          81,220,000
Fixed cost		$      4,100,000	$      4,100,000	$      4,100,000	$      4,100,000	$                 -		$          16,400,000
Working capital(@ 5%)		$         231,000	$         192,500	$        (539,000)				$             (115,500)
Reclaiming cost					$                 -	$      2,700,000		$           2,700,000
Total Costs	$                   -	$   (23,551,000)	$   (25,372,500)	$   (26,191,000)	$   (22,390,000)	$     (2,700,000)	$                 -	$       (100,204,500)
Revenue and Operating Benefits
Sales( @ $ 86 /ton for 500,000 tons and @$77/ton for remaining)		$    52,240,000	$    56,860,000	$    60,710,000	$    49,930,000	$                 -	$                 -	$        219,740,000
Selling of machine(net of depreciation)					$    27,322,000			$          27,322,000
return of Working capital					$      2,496,500			$           2,496,500
Benefit of charitable donation		$                 -	$                 -	$                 -	$                 -	$                 -	$     (6,000,000)	$          (6,000,000)
Total Benefits and Revenue	$                   -	$    52,240,000	$    56,860,000	$    60,710,000	$    79,748,500	$                 -	$     (6,000,000)	$        243,558,500
Cash Flow Before Taxes	$   (104,112,000)	$    28,689,000	$    31,487,500	$    34,519,000	$    57,358,500	$     (2,700,000)	$     (6,000,000)	$          39,242,000
Income Tax Calculation
Depreciation Expense		$   (13,575,500)	$   (23,265,500)	$   (16,615,500)	$   (11,865,500)	$                 -	$                 -	$         (65,322,000)
Operating Cost		$   (23,551,000)	$   (25,372,500)	$   (26,191,000)	$   (22,390,000)	$     (2,700,000)	$                 -	$       (100,204,500)
Operating Benefits		$    52,240,000	$    56,860,000	$    60,710,000	$    79,748,500	$                 -	$     (6,000,000)	$        243,558,500
Net Income Taxes	$                   -	$     (5,743,130)	$     (3,124,360)	$     (6,803,330)	$   (17,287,340)	$      1,026,000	$      2,280,000	$         (29,652,160)
Cash Flow After Taxes	$   (104,112,000)	$    36,521,370	$    51,628,640	$    44,331,170	$    51,936,660	$     (1,674,000)	$     (3,720,000)	$          74,911,840
Discounted Cash Flow (After Tax)	$   (104,112,000)	$    32,608,366	$    41,158,036	$    31,554,051	$    33,006,686	$        (949,873)	$     (1,884,668)	$          31,380,599
Business Case Results:				Assumptions:
NPV of Cash Flow	$      31,380,599			Cost Escalation Factor		0.00%
IRR	25.311%			Benefit Escalation Factor		0.00%
Profitability Index	1.30			Income Tax Rate		38.00%
Simple Payback	2 Years 4 Months			WACC		12.00%
Discounted Payback	2 Years 12 Months

The mine should be opened .