I have been asked by the President of Bethesda Mining Company to analyze a proposition by Mid-Ohio Electric Company to supply coal for its electric generators for the next four years. This proposition involves opening a new mine in Ohio, and making an investment in new equipment of $85,000,000, with a residual value to be transferred to a subsequent location of 60% of the purchase price, or $51,000,000. The equipment will be depreciated according to a 7-year MARCS schedule while in use on the mine associated with the contract.
I have entered the financial data into a spreadsheet in order to analyze the financial viability of the proposition. In doing so, I have made the following assumptions:
1. The initial investment of $85,000,000 is made prior to the first year of the contract in order that the equipment will be in place prior to the start of the contract period. Therefore the investment is made during “year 0” of the contract, and is already partially depreciated at the beginning of the contract term.
2. As indicated, the net working capital investment of 5% of the expected sales is built up in the year prior to the sales. In other words, during “year 0” an additional investment is needed in order to have sufficient working capital during the first operating year of the contract.
3. The equipment purchased for the fulfillment of the contract is neither fully depreciated, nor is it sold to a different entity, but rather the assets are transferred within the company from one operation to another. This ensures that there is no tax impact on the difference between the depreciated value and the sale price, as the depreciation will simply continue within the company. However, the value of the equipment can be added back in to the total investment on this project, and in an unrelated accounting entry can be deducted as a capital investment on the subsequent mine, thereby having taken the maximum... [continues]
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