Question No$.2($Bethesda Mining Company$)$ hal$173.$

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 $$6$ million. Based on a recent appraisal, the company feels it could

receive $$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 $$85$ 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 $60\%$ 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 $$95$ 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 $$90$ per ton. Variable costs amount to $$31$ per ton, and fixed costs are $$4,300,000$ million per year. The

mine will require a net working capital investment of $5\%$ 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

The company uses an outside company for reclamation of all the company's strip mines. It is estimated

the cost of reclamation will be $$2,800,000$ 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 $$7,500,000.$

Bethesda faces a $38\%$ tax rate and has a $12\%$ 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?