PowerPoint presentation, Ten or more slides

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BETHESDA MINING COMPANY

Background:

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 $5.4 million.

Based on a recent appraisal, the company feels it could receive $7.3 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. As they are currently operating at full capacity, Bethesda will need

to purchase additional equipment, which will cost $49 million. The equipment will be

depreciated on a seven year MACRS schedule. The contract only runs for 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

$70 per ton. Bethesda Mining feels that coal production will be 750,000 tons, 810,000 tons,

830,000 tons, and 720,000 tons, respectively, over the next four years. The excess production

will be sold in the spot market at an average of $64 per ton, Variable costs amount to $29 per

ton and fixed costs are $4.2 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 all the company's strip mines. It is estimated the cost of

reclamation will be $3.9 million. After the land is reclaimed, the company plans to donate the

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land to the state for use as a public park and recreation area as a condition to receive the

necessary mining permits. This will occur in Year 5 and result in a charitable expense deduction

of $7.3 million. Bethesda faces a 38 percent tax rate and has a 12 percent required return on

new strip mine projects. Assume a loss in any year will result in a tax credit.

Action:

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?

In your decision making, consider the impact to your calculations:

(1) if the variable cost is +- $2 per ton – what is the worst case and best case scenario;

(2) you anticipate that the president will assume this project may be a high risk which

the company typically considers to have an impact of +3% of the required return.

Conduct analysis to address these conditions. Is the contract still a good choice? List any

assumptions you made to a complete your analysis.

Develop a PowerPoint presentation with any supporting documents to provide to the

president.