Question

BETHESDA MINING COMPANY 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?

Please show ALL EXCEL FORMULAS!

Answer 1

Input area:
Land cost	$ 4,000,000
Aftertax land value	$ 6,500,000
Equipment	$ 95,000,000
Equipment salvage	60%
Contract sales/tons	500,000
Contract $/ton	$86
Year 1 production	620,000
Year 2 production	680,000
Year 3 production	730,000
Year 4 production	590,000
Spot market $/ton	$77
Variable cost/ton	$31
Fixed costs	$4,100,000
NWC percent	5%
Reclamation costs	$2,700,000
Charitable expense	$6,000,000
Tax rate	38%
Required return	12%
Year 1 depreciation	14.29%
Year 2 depreciation	24.49%
Year 3 depreciation	17.49%
Year 4 depreciation	12.49%

Output area:
Time 0 cash flow
Equipment	$ (95,000,000)
Land	(6,500,000)
NWC	(2,612,000)
Total	($104,112,000)
Sales	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Contract	$ 43,000,000	$ 43,000,000	$ 43,000,000	$ 43,000,000
Spot	9,240,000	13,860,000	17,710,000	6,930,000
Total	$ 52,240,000	$ 56,860,000	$ 60,710,000	$ 49,930,000
Sales	$ 52,240,000	$ 56,860,000	$ 60,710,000	$ 49,930,000
VC	19,220,000	21,080,000	22,630,000	18,290,000
FC	4,100,000	4,100,000	4,100,000	4,100,000	$ 2,700,000
Dep	13,575,500	23,265,500	16,615,500	11,865,500
EBT	$ 15,344,500	$ 8,414,500	$ 17,364,500	$ 15,674,500	$ (2,700,000)
Tax	5,830,910	3,197,510	6,598,510	5,956,310	(1,026,000)	(2,280,000)
NI	$ 9,513,590	$ 5,216,990	$ 10,765,990	$ 9,718,190	$ (1,674,000)	$ 2,280,000
+ Dep	13,575,500	23,265,500	16,615,500	11,865,500	-	-
OCF	$ 23,089,090	$ 28,482,490	$ 27,381,490	$ 21,583,690	$ (1,674,000)	$ 2,280,000
Beginning NWC	$ 2,612,000	$ 2,843,000	$ 3,035,500	$ 2,496,500
Ending NWC	2,843,000	3,035,500	2,496,500
NWC cash flow	$ (231,000)	$ (192,500)	$ 539,000	$ 2,496,500
Total cash flow	$ 22,858,090	$ 28,289,990	$ 27,920,490	$ 24,080,190	$ (1,674,000)	$ 2,280,000
Book value	$ 81,424,500	$ 58,159,000	$ 41,543,500	$ 29,678,000
Salvage	MV	$ 57,000,000
	BV	29,678,000
	Taxes	(10,382,360)
Salvage CF		$ 46,617,640
	Time	Cash flow
	0	$ (104,112,000)
	1	22,858,090
	2	28,289,990
	3	27,920,490
	4	70,697,830
	5	(1,674,000)
	6	2,280,000
Profitability index		1.0371
Average accounting return	9.76%
IRR		13.45%
IRR		13.45%
NPV		$ 3,857,864.51