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CHAPTER 6, Case #1
BETHESDA MINING
To analyze this project, we must calculate the incremental cash flows generated by the project. Since
net working capital is built up ahead of sales, the initial cash flow depends in part on this cash outflow.
So, we will begin by calculating sales. Each year, the company will sell 500,000 tons under contract,
and the rest on the spot market. The total sales revenue is the price per ton under contract times 500,000
tons, plus the spot market sales times the spot market price. The sales per year will be:
Year 1
Year 2
Year 3
Year 4
Contract
$43,000,000
$43,000,000
$43,000,000
$43,000,000
Spot
9,240,000
13,860,000
17,710,000
6,930,000
Total
$52,240,000
$56,860,000
$60,710,000
$49,930,000
The current aftertax value of the land is an opportunity cost. The initial outlay for net working capital
is the required net working capital percentage times Year 1 sales, or:
Initial net working capital = .05($52,240,000) = $2,612,000
So, the cash flow today is:
Equipment
–$95,000,000
Land
–6,500,000
Now we can calculate the OCF each year. The OCF is:
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Sales
$52,240,000
$56,860,000
$60,710,000
$49,930,000
Year 6, the charitable donation is irrelevant since it is required for the company to donate the land in
order to receive the necessary permits. However, the donation of the land does mean that the company
will receive a tax credit on the donation of the land, so this tax credit is relevant.
Next, we need to calculate the net working capital cash flow each year. NWC is 5 percent of next
year’s sales, so the NWC requirement each year is:
Book value of equipment = $29,678,000
Since the market value of the equipment is $57 million, the equipment is sold at a gain to book value,
so the sale will incur the taxes of:
Taxes on sale of equipment = ($29,678,000 – 57,000,000)(.25)
Taxes on sale of equipment = –$6,830,500
So, the net cash flows each year, including the operating cash flow, net working capital, and aftertax
salvage value, are:
Time
Cash flow
0
–$104,112,000
1
24,852,875
2
29,383,875
So, the capital budgeting analysis for the project is:
Payback period = 3 + $19,697,375/$76,287,375
Payback period = 3.26 years
The NPV is:
The equation for IRR is:
Using a spreadsheet or financial calculator, the IRR for the project is:
IRR = 16.11%
