Bethesda Mining is a midsized coal mining company with 20 mines located in Uhio, Pennsylvanla, 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 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 $5 million. Based on a recent appraisal, the company feels it còuld receive $4.2 million on an after-tax basis if it sold the land today. Strip mining is a process where the layers of topsoil above vein are removed and the exposed soil is removed. Some time ago, the company would simply remove the coil and leave the land in an unusable condition. Changes in the mining regulations now force the a company to reclaim the land;"that is, when 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 $32 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. 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 $40 per ton. Bethesda Mining feels that coal production will be 530,000 tons, 630,000 tons, 700,000 tons, and
Bethesda Mining is a midsized coal mining company with 20 mines located in Uhio, Pennsylvanla, 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 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 $5 million. Based on a recent appraisal, the company feels it còuld receive $4.2 million on an after-tax basis if it sold the land today. Strip mining is a process where the layers of topsoil above vein are removed and the exposed soil is removed. Some time ago, the company would simply remove the coil and leave the land in an unusable condition. Changes in the mining regulations now force the a company to reclaim the land;"that is, when 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 $32 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. 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 $40 per ton. Bethesda Mining feels that coal production will be 530,000 tons, 630,000 tons, 700,000 tons, and
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text: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 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 $5 million. Based
on a recent appraisal, the company feels it could receive $4.2 million on an after-tax basis if it sold
the land today.
Strip mining is a process where the layers of topsoil above vein are removed and the
exposed soil is removed. Some time ago, the company would simply remove the coil and leave the
land in an unusable condition. Changes in the mining regulations now force the a company to
reclaim the land; that is, when 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 $32
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. 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 $40 per ton.
Bethesda Mining feels that coal production will be 530,000 tons, 630,000 tons, 700,000 tons, and
Transcribed Image Text:630,000 tons, respectively, over the next four years. The excess production will be sold in the spot
market at an average of $45 per ton. Variable costs amount to $15 per ton, and fixed costs are
$2,200,000 per year. The mine will require a net working capital investment of 2 percent of sales.
The NWC will be built up in the year prior to sales.
Bethesda will be responsible for reclaiming (cleaning) the land at termination of the
mining. This will occur in year 5. The company uses an outside company for reclamation of all
the company's strip mines. It is estimated the cost of reclamation will be $3 million. In 5 years,
after the land is cleaned, the company plans to sell the land at an expected after-tax price of $2.5
million.
Bethesda faces a 40 percent tax rate and has a 14 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?
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