Bethesda Mining is a midsized coal mining company with 20 mines located in Ohio, Pennsylvania, West Virginia,...

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Bethesda Mining is a midsized coal mining company with 20 mineslocated in Ohio,
Pennsylvania, West Virginia, and Kentucky. The company operatesdeep mines as well as strip
mines. Most of the coal mined is sold under contract, withexcess production sold on the spot
market.
The coal mining industry, especially high-sulfur coal operationssuch as Bethesda, has
been hard-hit by environmental regulations. Recently, however, acombination of increased
demand for coal and new pollution reduction technologies has ledto an improved market
demand for high-sulfur coal. Bethesda has just been approachedby Mid-Ohio Electric
Company with a request to supply coal for its electricgenerators for the next four years.
Bethesda Mining does not have enough excess capacity at itsexisting mines to guarantee the
contract. The company is considering opening a strip mine inOhio on 5,000 acres of land
purchased 10 years ago for $4 million. Based on a recentappraisal, the company feels it
could receive $6.5 million on an aftertax basis if it sold theland today.
Strip mining is a process where the layers of topsoil above acoal vein are removed and
the exposed coal is removed. Some time ago, the company wouldsimply remove the coal and
leave the land in an unusable condition. Changes in miningregulations now force a company
to reclaim the land; that is, when the mining is completed, theland must be restored to near
its original condition. The land can then be used for otherpurposes. Because it is currently
operating at full capacity, Bethesda will need to purchaseadditional necessary equipment,
which will cost $95 million. The equipment will be depreciatedon a seven-year MACRS
schedule. The contract runs for only four years. At that timethe coal from the site will be
entirely mined. The company feels that the equipment can be soldfor 60 percent of its initial
purchase price in four years. However, Bethesda plans to openanother 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 peryear 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. Theexcess production will be sold in
the spot market at an average of $77 per ton. Variable costsamount to $31 per ton, and fixed
costs are $4,100,000 per year. The mine will require a networking capital investment of 5
percent of sales. The NWC will be built up in the year prior tothe sales.
Bethesda will be responsible for reclaiming the land attermination of the mining. This will
occur in Year 5. The company uses an outside company forreclamation 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 todonate the land after reclamation
to the state for use as a public park and recreation area. Thiswill occur in Year 6 and result
in a charitable expense deduction of $6 million. Bethesda facesa 38 percent tax rate and has
a 12 percent required return on new strip mine projects. Assumethat a loss in any year will
result in a tax credit.
You have been approached by the president of the company with arequest 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 Miningtake the contract and open
the mine?

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4.2 Ratings (889 Votes)

Depreciation Y0 1 2 3 4 Net Capital Costs Depreciation Expense 135755000 232655000 166155000 118655000 Depreciation 5 Year MACRS 1429 2449 1749 1249 value of machine after 4 the year 2967800 Profit on sell of equipment 95000000 60 29678000 27322000 Net Cash Flow Y0 1 2 3 4 5 6 Totals Net Capital Costs New equipment cost 95000000 Land cost 6500000 Working capital for 1 yr sales5 See Answer

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Transcribed Image Text

Bethesda Mining is a midsized coal mining company with 20 mineslocated in Ohio,Pennsylvania, West Virginia, and Kentucky. The company operatesdeep mines as well as stripmines. Most of the coal mined is sold under contract, withexcess production sold on the spotmarket.The coal mining industry, especially high-sulfur coal operationssuch as Bethesda, hasbeen hard-hit by environmental regulations. Recently, however, acombination of increaseddemand for coal and new pollution reduction technologies has ledto an improved marketdemand for high-sulfur coal. Bethesda has just been approachedby Mid-Ohio ElectricCompany with a request to supply coal for its electricgenerators for the next four years.Bethesda Mining does not have enough excess capacity at itsexisting mines to guarantee thecontract. The company is considering opening a strip mine inOhio on 5,000 acres of landpurchased 10 years ago for $4 million. Based on a recentappraisal, the company feels itcould receive $6.5 million on an aftertax basis if it sold theland today.Strip mining is a process where the layers of topsoil above acoal vein are removed andthe exposed coal is removed. Some time ago, the company wouldsimply remove the coal andleave the land in an unusable condition. Changes in miningregulations now force a companyto reclaim the land; that is, when the mining is completed, theland must be restored to nearits original condition. The land can then be used for otherpurposes. Because it is currentlyoperating at full capacity, Bethesda will need to purchaseadditional necessary equipment,which will cost $95 million. The equipment will be depreciatedon a seven-year MACRSschedule. The contract runs for only four years. At that timethe coal from the site will beentirely mined. The company feels that the equipment can be soldfor 60 percent of its initialpurchase price in four years. However, Bethesda plans to openanother strip mine at that timeand will use the equipment at the new mine.The contract calls for the delivery of 500,000 tons of coal peryear 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. Theexcess production will be sold inthe spot market at an average of $77 per ton. Variable costsamount to $31 per ton, and fixedcosts are $4,100,000 per year. The mine will require a networking capital investment of 5percent of sales. The NWC will be built up in the year prior tothe sales.Bethesda will be responsible for reclaiming the land attermination of the mining. This willoccur in Year 5. The company uses an outside company forreclamation of all the company’sstrip mines. It is estimated the cost of reclamation will be$2.7 million. In order to get thenecessary permits for the strip mine, the company agreed todonate the land after reclamationto the state for use as a public park and recreation area. Thiswill occur in Year 6 and resultin a charitable expense deduction of $6 million. Bethesda facesa 38 percent tax rate and hasa 12 percent required return on new strip mine projects. Assumethat a loss in any year willresult in a tax credit.You have been approached by the president of the company with arequest to analyzethe project. Calculate the payback period, profitability index,net present value, and internalrate of return for the new strip mine. Should Bethesda Miningtake the contract and openthe mine?