Question

Montana Mining Co. (MMC) paid 200 million for the right to explore and extract rare metals from land owned by the state of Montana. To obtain the rights, MMC agreed to restore the land to a suitable condition for other uses after its exploration and extraction activities. MMC incurred exploration and development cost of $60 million. MMC has a credit-adjusted risk free interest rate of 7%. It estimates the possible cash flows for restoring the land, 3 years after extraction activities begin, as follows:

Cash Outflow Probability

$10 million 60%
$30 million 40%

The asset retirement obligation (rounded) that should be recognized at the beginning of the extraction activities is: ________
The asset retirement obligation (rounded) that should be reported on the balanace sheet one year after activities begin is: _______

Answer 1

A. $14.7 million

B.$15.7 million

Step-by-step explanation:

A. Calculation for The asset retirement obligation that should be recognized at the beginning of the extraction activities

PV of the expected cash flows=0.81630 *[(.60 *$10 million) + (.40 $30 million)]

PV of the expected cash flows=0.81630*($6 million+$12 million)

PV of the expected cash flows=0.81630*$18 million

PV of the expected cash flows=$14,693,400

PV of the expected cash flows=$14.7 million (rounded)

Therefore The asset retirement obligation that should be recognized at the beginning of the extraction activities is:$14.7 million

B. Calculation for The asset retirement obligation that should be reported on MMC's balance sheet one year after the extraction activities begin

Asset retirement obligation=$14.7 million ×(1+.07)

Asset retirement obligation=$14.7 million × 1.07

Asset retirement obligation = $15.7 million (rounded)

Therefore The asset retirement obligation that should be reported on the balanace sheet one year after activities begin is:$15.7 million