Bethesda Mining is a midsized company. 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 this contract. The company is considering opening a strip mine in Ohio on 5,000 acres of land purchased 10 years ago for $6million. Based on a recent appraisal the company feels it could receive $5 million on aftertax basis if it sold the land today.

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 operating at full capacity, Bethesda will need to purchase additional necessary equipment which will cost $30 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 600,000 tons of coal per year at a price of $34 per ton. Bethesda mining feels that coal production will be 650,000 tons, 725,000 tons, 810,000 tons and 740,000 tons respectively over the next four years. The excess s production will be sold in the spot market at an average of $40 per ton. Variable costs amount to $13 per ton and fixed costs are $2,500,000 per year. The mine will require a net working capital investment of 5% sales. The net working capital will be built up in the year prior to sales.

Bethesda will be responsible for reclaiming the land at termination of the mining. This will occur in year 5. The company does use an outside company for reclamation of all the company’s strip mines. It is estimated the cost of the reclamation will be $4million. After the land is reclaimed the company plans to donate the land to the state for use as a public park and recreation area. T his will occur in year 6 and result in a charitable expense deduction of $6million. 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.

Analyze the project. Calculate the payback period, profitability index, average accounting return, net present value, and internal rate of return and modified internal rate of return for the new strip mine. Should Bethesda Mining take the contract and open the mine?