Bethesda Mining is a midsized coal mining company with 20 mines located in Ohio,
ID: 2650377 • Letter: B
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 exist-
ing 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 $5 million. Based on a recent
appraisal, the company feels it could receive $5.5 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 pur-
chase additional necessary equipment, which will cost $85 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 $82 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 produc-
tion will be sold in the spot market at an average of $76 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 inter-
nal rate of return for the new strip mine. Should Bethesda Mining take the contract and
open the mine?
Explanation / Answer
Net Present Value = 9,598,839.10
Internal Rate of Return = 16.341%
As Projects NPV is +ve and it is $9,598,839.10, project should be accepted.
Market price of Land 5,500,000.00 Cost of the equipment 85,000,000.00 Cash outflows 90,500,000.00 Less: Solvage after 4 year 48,450,000.00 Cash Outflows 42,050,000.00 Year Year-1 Year-2 Year-3 Year-4 Total Production 620,000 680,000 730,000 590,000 2,620,000 Sale upto 500,000 tonn @82 per ton 41,000,000.00 41,000,000.00 41,000,000.00 41,000,000.00 164,000,000 Sale above 500.000 tonn @$76 per tonn 9,120,000.00 13,680,000.00 17,480,000.00 6,840,000.00 47,120,000 Total Sales 50,120,000.00 54,680,000.00 58,480,000.00 47,840,000.00 211,120,000 Variable Cost @$31 per ton 19,220,000.00 21,080,000.00 22,630,000.00 18,290,000.00 81,220,000 Fixed Cost 4,100,000.00 4,100,000.00 4,100,000.00 4,100,000.00 16,400,000 Total Cost 23,320,000.00 25,180,000.00 26,730,000.00 22,390,000.00 97,620,000 Income 26,800,000.00 29,500,000.00 31,750,000.00 25,450,000.00 113,500,000 Depreciation % as per MACRS Schedule 20% 32% 19% 11.52% 82.52% Depreciation 17,000,000.00 27,200,000.00 16,150,000.00 9,792,000.00 70,142,000 Net Income 9,800,000.00 2,300,000.00 15,600,000.00 15,658,000.00 43,358,000 Tax @ 39% 3,822,000.00 897,000.00 6,084,000.00 6,106,620.00 16,909,620 Net Income 5,978,000.00 1,403,000.00 9,516,000.00 9,551,380.00 26,448,380 Addback Depreciation 17,000,000.00 27,200,000.00 16,150,000.00 9,792,000.00 70,142,000 Operating Cash Inflows 22,978,000.00 28,603,000.00 25,666,000.00 19,343,380.00 96,590,380 Add Solvage 48,450,000.00 Net Cash inflows 22,978,000.00 28,603,000.00 25,666,000.00 67,793,380.00 96,590,380.00 Answer: Payback amount 22,978,000.00 19,072,000.00 42,050,000 Payback period in years 1 0.666783205 1.67 Profitability Index = Cash inflows/Cash Outflows Profitability index=$96,590,380/$42,050,000 = 2.30 Present Value Year Cashflows PV Factor at 12% at 12% 13% 14% 15% 16% 16.341% 17% 0 (90,500,000.00) 1 (90,500,000.00) -90500000 -90500000 -90500000 -90500000 -90500000 -90500000 1 22,978,000.00 0.892857143 20,516,071.43 20334513.27 20156140.35 19980869.57 19808620.69 19750562.72 19639316.24 2 28,603,000.00 0.797193878 22,802,136.48 22400344.58 22009079.72 21627977.32 21256688.47 21132266.72 20894879.1 3 25,666,000.00 0.711780248 18,268,551.84 17787825.47 17323818.93 16875811.62 16443119.85 16298961.57 16025094.7 4 67,793,380.00 0.635518078 43,083,918.59 41578949.57 40139123.23 38761085.04 37441680.27 37004648.37 36177940.51 5 (2,700,000.00) 0.567426856 (1,532,052.51) -1465451.827 -1402295.394 -1342377.185 -1285505.142 -1266776.527 -1231500.111 6 (6,000,000.00) 0.506631121 (3,039,786.73) -2881911.165 -2733519.286 -2593965.575 -2462653.528 -2419662.212 -2339031.55 Total 45,840,380.00 9,598,839.10 7,254,269.90 4,992,347.56 2,809,400.79 701,950.60 0.64 (1,333,301.11) Payback period 1.67 years Profitability Index = Cash inflows/Cash Outflows Profitability index=$96,590,380/$42,050,000 = 2.30Net Present Value = 9,598,839.10
Internal Rate of Return = 16.341%
As Projects NPV is +ve and it is $9,598,839.10, project should be accepted.
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