Pickins mining case | Business & Finance homework help

Pickins Mining is a midsized coal mining company with 20 mines located in Ohio, 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 Pickins, 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. Pickins has just been approached by Middle-Ohio Electric Company with a request to supply

coal for its electric generators for the next four years. Pickins 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 $7.5 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. As they are currently operating at full

capacity, Pickins will need to purchase additional equipment, which will cost $46 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, Pickins 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 450,000 tons of coal per year at a price of $65 per ton.

Pickins Mining feels that coal production will be 770,000 tons, 830,000 tons, 850,000 tons, and

740,000 tons, respectively, over the next four years. The excess production will be sold in the

spot market at an average of $82 per ton. Variable costs amount to $26 per ton and fixed costs

are $3.9 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.

Pickins 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 $5.5 million. After the land is reclaimed, the company

plans to donate the land 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 $7.5 million. Pickins 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.

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. You need to show all your calculations. Should Pickins Mining take

the contract and open the mine? Explain in detail, showing calculations, so the instructor can

follow your thoughts.

You may also include an Excel spreadsheet if you would like to show the calculations that way (in

addition to the paper part).