NWR MINING COMPANY
New World Resources Plc (NWR), London based company is a hard coal and coke producers. The Company produces coking and thermal coal for the steel and energy sectors in Central Europe through its subsidiary. NWR's coke subsidiary, OKK Koksovny, a.s. (OKK) is a producer of foundry coke. NWR supplies to a customer base in the region, including ArcelorMittal, U.S. Steel, voestalpine, Dalkia, CEZ, Verbund, Moravia Steel, and ThyssenKrupp. NWR mines in the Czech Republic and has several development projects in both Poland and the Czech Republic.
The coal mining industry, especially high-sulfur coal operations such as NWR, has been hard-hit by environmental regulations and warmer than expected winter 2014/2015. 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. NWR has just been approached by Opole Electric Company with a request to supply coal for its electric generators for the next four years. NWR does not have enough excess capacity at its existing mines to guarantee the contract. The company is considering opening a strip mine in Walbrzych on 5,000 acres of land purchased 10 years ago for $6 million. Based on a recent appraisal, the company feels it could receive $7 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. 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, NWR will need to purchase additional necessary equipment, which will cost $85 million. The equipment will be depreciated on a seven-year linear 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.
The contract calls for the delivery of 500,000 tons of coal per year at a price of $95 per ton. NWR 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 $88 per ton but the spot prices are highly volatile. The fact should be taken into consideration in the analysis. Variable costs amount to $31 per ton, and fixed costs are $4,300,000 per year. The mine will require a net working capital of 5 percent of sales. The NWC will be built up in the year prior to the sales.
NWR 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 $2.8 million. NWR faces a 19 percent tax rate and has a 12 percent required return on invested capital. Assume that a loss in any year will result in a tax credit.
You have been approached by the CFO of the company with a request to analyze the project.
Calculate the payback period, net present value, internal rate of return for the new strip mine. Prepare also sensitivity analysis of this project. Should NWR Mining take the contract and open the mine?