Case Study For this assignment, following APA style, answer as comprehensively a
ID: 2743366 • Letter: C
Question
Case Study
For this assignment, following APA style, answer as comprehensively as possible the questions after each case summary.
Please read the closing case “BETHESDA MINING” at the end of chapter 8 page and submit your analysis to your professor at the end of this session.
Answers must be well thought-out and in discussion format. Short one-liner answers are not sufficient.
- Answer the five questions at the end of the Case Synopsis and Purpose
- Repeat each question ahead of your answer
- Use headings to separate the response to each question
- Make sure you answer each question
- Follow APA style
- Check grammar, spelling, sentence structure, etc
I strongly suggest you use a good proofreader for each written submission.
Explanation / Answer
Ans;
To be able to analyze the project, we need to calculate the projects NPV, IRR, MIRR, Payback Period, and Profitability Index.
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 600,000 tons under contract, and the rest on the spot market. The total sales revenue is the price per ton under contract times 600,000 tons, plus the spot market sales times the spot market price. The sales per year will be:
Year
1
2
3
4
Contract
20,400,000
$20,400,000
$20,400,000
$20,400,000
Spot
$2,000,000
$5,000,000
$8,400,000
$5,600,000
Total
$22,400,000
$25,400,000
$28,800,000
$26,000,000
The current after-tax value of the land is an opportunity cost. The initial outlay for net working capital is the percentage required net working capital times Year 1 sales, or:
Initial net working capital = .05($22,400,000) = $1,120,000
So, the cash flow today is:
Equipment $30,000,000
Land 5,000,000
NWC 1,120,000
Total $36,120,000
Now we can calculate the OCF each year. The OCF is:
Year
1
2
3
4
5
6
Annual
Revenue
$22,400,000
$25,400,000
$28,800,000
$26,000,000
Less: Variable
Costs
$8,450,000
$9,425,000
$10,530,000
$9,620,000
Less: Fixed
Costs
$2,500,000
$2,500,000
$2,500,000
$2,500,000
$4,000,000
$6,000,000
Less: Depreciation
$4,290,000
$7,350,000
$5,250,000
$3,750,000
EBIT
$7,160,000
$6,125,000
$10,520,000
$10,130,000
($4,000,000)
($6,000,000)
Tax @ 34%
$2,434,400
$2,082,500
$3,576,800
$3,444,200
($1,360,000)
($2,040,000)
Net Income
$4,725,600
$4,042,500
$6,943,200
$6,685,800
($2,640,000)
($3,960,000)
Add: Depreciation
$4,290,000
$7,350,000
$5,250,000
$3,750,000
OCF
$9,015,600
$11,392,500
$12,193,200
$10,435,800
($2,640,000)
($3,960,000)
Years 5 and 6 are of particular interest. Year 5 has an expense of $4 million to reclaim the land, and
it is the only expense for the year. Taxes that year are a credit, an assumption given in the case. In
Year 6, the charitable donation of the land is an expense, again resulting in a tax credit. The land
does have an opportunity cost, but no information on the after-tax salvage value of the land is
provided. The implicit assumption in this calculation is that the after-tax salvage value of the land in
Year 6 is equal to the $6 million charitable expense.
Next, we need to calculate the net working capital cash flow each year. NWC is 5 percent of next
years sales, so the NWC requirement each year is:
Year
0
1
2
3
4
5
6
Beginning WC
$1,120,000
$1,270,000
$1,440,000
$1,300,000
Ending WC
$1,270,000
$1,440,000
$1,300,000
$0
NWC CF
($150,000)
($170,000)
$140,000
$1,300,000
The last cash flow we need to account for is the salvage value. The fact that the company is keeping
the equipment for another project is irrelevant. The after-tax salvage value of the equipment should
be used as the cost of equipment for the new project. In other words, the equipment could be sold
after this project. Keeping the equipment is an opportunity cost associated with that project. The
book value of the equipment is the original cost, minus the accumulated depreciation, or:
Book value of equipment = $30,000,000 4,290,000 7,350000 5,2502,000 3,750,000
Book value of equipment = $9,360,000
Since the market value of the equipment is $18 million, the equipment is sold at a gain to book
value, so the sale will incur the taxes of:
Taxes on sale of equipment = ($18,000,000 9,360,000)(.34) = $2,937,600
And the after-tax salvage value of the equipment is:
After-tax salvage value = $18,000,000 2,937,600
After-tax salvage value = $15,062,400
So, the net cash flows each year, including the operating cash flow, net working capital, and after-tax
salvage value, are:
Year
0
1
2
3
4
5
6
Capital
Spending
($30,000,000)
$0
$0
$0
$15,062,400
$0
$0
Opportunity
Cost
($5,000,000)
NWC
($1,120,000)
($150,000)
($170,000)
$140,000
$1,300,000
OCF
$9,015,600
$11,392,500
$12,193,200
$10,435,800
($2,640,000)
($3,960,000)
Total Project
Cash Flow
($36,120,000)
$8,865,600
$11,222,500
$12,333,200
$26,798,200
($2,640,000)
($3,960,000)
So, the capital budgeting analysis for the project is:
Payback period = 3 + $3,698,700/$26,798,200
Payback period = 3.14 years
Profitability index =
Profitability index = 1.08
The equation for IRR is:
I have calculated the IRR using Trial & Error as noted on the attached excel sheet, the IRR = 15.6%.
MIRR = 13.39%
Year
0
1
2
3
4
5
6
OCF
($36,120,000)
$8,865,600
$11,222,500
$12,333,200
$26,798,200
($2,640,000)
($3,960,000)
PV Factor
@ 12%
1
0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
Year
1
2
3
4
Contract
20,400,000
$20,400,000
$20,400,000
$20,400,000
Spot
$2,000,000
$5,000,000
$8,400,000
$5,600,000
Total
$22,400,000
$25,400,000
$28,800,000
$26,000,000