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 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\mathrm{.}2$ million. Based on a recent appraisal,

the company feels it could receive $$6\mathrm{.}7$ 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 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 $$105$ 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 $$89$ per ton. Bethesda Mining feels that coal production will be $660,000$ tons, $720,000$ tons,

$760,000$ tons, and $620,000$ 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 $$30$ per ton, and fixed costs are $$4\mathrm{.}1$ million 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 Page $204$

all the company's strip mines. It is estimated the cost of reclamation will be $$2\mathrm{.}4$ 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 $$7$ million. Bethesda

faces a $25$ 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?