BETHESDA MINING COMPANY 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 Mining, 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 Mining 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 $7 million. Based on a recent appraisal, the company feels it could receive $6.5 million on an after-tax 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 Mining will need to purchase additional necessary equipment, which will cost $74 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 55 percent of its initial purchase price in four years.

The contract calls for the delivery of 525,000 tons of coal per year at a price of $91 per ton. Bethesda Mining feels that coal production will be 570,000 tons, 690,000 tons, 715,000 tons, and 580,000 tons, respectively, over the next four years. The excess production will be sold in the spot market at an average of $85 per ton. Variable costs amount to $29 per ton, and fixed costs are $4,250,000 per year. With the launch of the project, an immediate net working capital investment of $42,000 will be required. The investment in net working capital will increase by 6% each year during the first 3 years of the projects life. NWC will be completely recovered by the end of the project.

The company feels that the market value of the land at the end of the projects life will be $7.5 million. Bethesda Mining faces a 35 percent tax rate and has an 11 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 net present value, 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? How sensitive is NPV to a 1% decrease in its forecasted annual production figures? It's required that your work must be shown.