CB3410 Financial Management Case Study

This assignment is a case study focusing on Bethesda Mining Company's decision to open a new strip mine. Students are tasked with performing a comprehensive financial analysis of the project, including calculating the payback period, profitability index, net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR). The analysis requires estimating cash flows, considering factors like revenue from coal sales, variable and fixed costs, depreciation, reclamation expenses, and tax implications. A sensitivity analysis is also required, examining the impact of changes in fixed costs on the NPV. The final deliverable is a report that presents the findings and a recommendation on whether Bethesda Mining should proceed with the project. The case study involves applying capital budgeting techniques to a real-world scenario, requiring students to demonstrate their understanding of financial modeling and decision-making under uncertainty.

Group Assignment #2
Due date: Lecture 11 (November 17th).
(You are given three weeks to complete the
assignment)
Department of Economics and
Finance CB3410, Financial
Management Semester A,
2016/17, Dr. Ryoonhee Kim
Read the following case carefully and answer the questions in the
bottom. Show all the works you need to do to get final answer. Each
step to obtain the final answer should be shown or explained (e.g.
why you choose to do in such a way). An answer without explanation
will get 0 point. (Even if you submit an excel file, You should submit
one report per group and put all the names of your group members
on the report. The submission can be in a hard copy or a soft copy of
your answer. You should bring a hard copy to me in class or send a
soft copy by email to TA, Gobin Rana ([e-mail]) on or
before the due date stated above. No late submission will be
accepted.
Mini Case Study: Bethesda Mining Company
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 $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 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 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 percent 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 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 $2.8million. After the
land is reclaimed, the company plans to donate the land to the state
for use a public park and recreation area. This will occur in year 6 and
result in a charitable expense of $7.5 million. Bethesda faces a 38
percent tax rate in the new project and has a 12 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, internal
rate of return, and modified internal rate of return for the new
strip mine. (You need to estimate cash flows of the project
before you apply the capital budgeting criteria) Should
Bethesda Mining take the contract and open the mine?
Do a sensitivity analysis based on change in fixed costs.
Recalculate NPV assuming that fixed costs are increased by 20%.
Recalculate NPV assuming that fixed costs are decreased by
20%. How much in percentage of NPV changes in response to
the increase/decrease in fixed costs? Plot NPV values for the
different levels of fixed costs. Is NPV very much sensitive to the
changes in the fixed costs?