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After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation

must decide whether to go ahead and develop the deposit. The most cost-effective method of

mining gold is sulfuric acid extraction, a process that could result in environmental damage.

Before proceeding with the extraction, CTC must spend $900,000 for new mining equipment

and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000

each year for the 5-year life of the vein. CTC’s cost of capital is 14%. For the purposes of this

problem, assume that the cash inflows occur at the end of the year.

a. What are the project’s NPV and IRR?

b. Should this project be undertaken if environmental impacts were not a consideration?

c. How should environmental effects be considered when evaluating this, or any other,

project? How might these concepts affect the decision in part b?

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Bunny Greenfelder
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29 Sep 2019

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After discovering a new gold vein in the Colorado Mountains CTCMining Corporation must decide whether to mine the deposit. Themost cost-effective method of mining gold is sulfuric acidextraction, a process that results in environmental damage. To goahead with the extraction, CTC must spend $900,000 for new miningequipment and pay $165,000 for its installation. The gold minedwill net the firm an estimated $350,000 each year over the 5-yearlife of the vein. CTC’S cost of capital is 14 percent. For thepurposes of this problem, assume that the cash inflows occur at theend of the year.
a. What are the NPV and IRR of this project?
b. Should this project be undertaken, ignoring environmentalconcerns?
c. How should environmental effects be considered when evaluatingthis, or any other, project? How might these effects change yourdecision in part b?

Problem 10-12
NPV and IRR Analysis

After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. Before proceeding with the extraction, CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year over the 5-year life of the vein. CTC's cost of capital is 13%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.

What is the project's NPV? Round your answer to the nearest dollar.
$
What is the project's IRR? Round your answer to two decimal places.
%

Should this project be undertaken if environmental impacts were not a consideration?
-Select-YesNo

How should environmental effects be considered when evaluating this, or any other, project?
-Select-
I. Environmental effects should be treated as sunk costs.
II. Environmental effects could be added by estimating penalties or any other cash outflows that might be imposed on the firm to help return the land to its previous state (if possible).
III. Environmental effects should be ignored since they would have no effect on the project's profitability.

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 $5.5 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. Because it is currently operating at full capacity, Bethesda will need to purchase additional necessary equipment, which will cost $80 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 $82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 $76 per ton. Variable costs amount to $31 per ton, and fixed costs are $4,100,000 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 $2.9 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 $6 million. Bethesda faces a 38percent tax rate and has a 11.5 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? Show your work!

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