1 | P a g eBETHESDA MINING COMPANYBackground: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 undercontract, with excess production sold on the spot market. The coal mining industry, especiallyhighsulfur coal operations such as Bethesda, has been hard hit by environmental regulations.Recently, however, a combination of increased demand for coal and new pollution reductiontechnologies 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 coalfor its electric generators for the next four years. Bethesda Mining does not have enoughexcess capacity at its existing mines to guarantee the contract. The company is consideringopening a strip 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 basisif it sold the land today.Strip mining is a process where the layers of topsoil above a coal vein are removed and theexposed coal is removed. Some time ago, the company would simply remove the coal and leavethe land in an unusable condition.Changes in mining regulations now force a company to reclaim the land that is, when themining is completed, the land must be restored to near its original condition. The land can thenbe used for other purposes. As they are currently operating at full capacity, Bethesda will needto purchase additional equipment, which will cost $49 million. The equipment will bedepreciated on a seven year MACRS schedule. The contract only runs for four years. At thattime the coal from the site will be entirely mined. The company feels that the equipment can besold for 60 percent of its initial purchase price.However, Bethesda plans to open another strip mine at that time and will use the equipment atthe new mine. The contract calls for the delivery of 500,000 tons of coal per year at a price of$70 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 productionwill be sold in the spot market at an average of $64 per ton, Variable costs amount to $29 perton and fixed costs are $4.2 million per year. The mine will require a net working capitalinvestment of 5 percent of sales.The NWC will be built up in the year prior to the sales. Bethesda will be responsible forreclaiming the land at termination of the mining. This will occur in Year 5. The company uses anoutside company for reclamation of all the company's strip mines. It is estimated the cost ofreclamation will be $3.9 million. After the land is reclaimed, the company plans to donate the 2 | P a g eland to the state for use as a public park and recreation area as a condition to receive thenecessary mining permits. This will occur in Year 5 and result in a charitable expense deductionof $7.3 million. Bethesda faces a 38 percent tax rate and has a 12 percent required return onnew strip mine projects. Assume a loss in any year will result in a tax credit.Action:You have been approached by the president of the company with a request to analyze theproject. Calculate the payback period, profitability index, net present value, and internal rate ofreturn for the new strip mine.Should Bethesda Mining take the contract and open the mine? In your decision making,consider the impact to your calculations, if the variable cost is +- $2 per ton and you anticipatethat the president will assume this project may be a high risk which typically considered to havea +2% required return.