Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and

Question

Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and development costs totaled $5.6 million. After the silver is extracted in approximately five years, Smithson is obligated to restore the land to its original condition, including constructing a wildlife preserve. The company's controller has provided the following three cash flow possibilities for the restoration costs: (1) $500,000, 20% probability; (2) $550,000, 45% probability, and (3) $650,000, 35% probability. The company's credit-adjusted, risk-free rate of interest is 6%. (FV of $1, PV of $1. EVA of $1, PVA of $1. EVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) What is the book value of the asset retirement liability at the end of one year? (Enter your answer in whole dollars.) Assuming that the actual restoration costs incurred after extraction is completed are $596,000, what amount of gain or loss will Smithson recognize on retirement of the liability? (Enter your answer in whole dollars.) Liability

Explanation / Answer

Details Cost Probability Expected cost Cash flow for restoration cost 500000 20% 100000 550000 45% 247500 650000 35% 227500 Expected cash flow 575000 So expected cash flow for restoration cost at year 6= 575000 credit adjusted Interest rate   6% PV factor fo year one end =1/1.06^5= 0.75 PV of the liability at year one end = 431250 Actual restoration cost incurred 596000 Loss on liability estimate to be recognized (596000-575000) 21000

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