Big Hole Mining Company (BH) has had most of its strip mining on hold for several years due to public opposition. While it's difficult to accurately assess public opinion, management now believes reclaiming regulations and new technology have significantly reduced potential opposition, and that a new mine can be opened. They have asked you to do the following:

A. Evaluate the project financials using the 15% BH standard corporate hurdle rate and the following assumptions:

The mine would be on land bought 10 years ago for $6,000,000, but a recent appraisal valued the property at $3,400,000 after taxes.

The sales contract for this mine runs for 4 years at which time the site will be entirely mined.

The contract calls for the following tons at a fixed price of $35.00 per ton.

Year Tons (000)

1 640

2 726

3 811

4 743

$25,000,000 of additional equipment will be needed immediately and will be on a 7 year MACRS depreciation schedule.

The equipment will be sold at the end of the sales contract for an estimated $14,700,000 after taxes.

A net working capital investment of 5% of incremental sales will also be required, but it will be totally recovered in year 4.

Variable costs are $13.00 per ton.

Estimated fixed costs for the 4 year project life include the following:

Annual financing costs of $200,000 beginning in year 1.

$100,000 to be spent in year 1 for PR and support of local community.

Other annual direct costs of $2,500,000 beginning in year 1.

$500,000 of annual allocated general corporate overhead beginning in year 2.

As required by government regulations, BH will reclaim the land at an after-tax cost of $4,000,000 in year 5 and $7,600,000 in year 6.

It will then sell the land in year 6 for $1,000,000 after taxes.

The effective combined state and federal tax rate is 25%.

INPUT AREA ($000) MACRS-7 YR Land sale value-current (opportunity value) Land salvage (sale) value AWNH Equipment Equipment salvage value Net WC investment-% of incremental sales Price / ton Tons (Thousands): AWNY Variable costs / ton Annual fixed costs Communication expense-year 1 Reclaim. Costs-year 5 Reclaim. Costs-year 6 Interest Tax rateOUTPUT AREA BIG HOLE CAPITAL PROJECT ($000) Investments 0 1 2 3 4 5 6 Land @ sale value Equipment Net working capital @ 5% Total investment Operating Cash Flows Units (thousand tons) Sales $ Variable costs per ton Annual Fixed costs Communication costs Reclaiming costs (after tax) Depreciation BIT Interest Taxable Income Taxes Net Income Add back depreciation Add back interest Total operating cash flow Termination Recoveries (after tax) Return of net working capital Equipment net salvage value Land net sale value Total termination cash flow Free Cash Flow NPV @15 % hurdle rate IRR