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 $6.6 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) $600,000, 35% probability; (2) $650,000, 50% probability; and (3) $750,000, 15% probability. The company’s credit-adjusted, risk-free rate of interest is 6%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD 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.)

Liability?

Assuming that the actual restoration costs incurred after extraction is completed are $696,000, what amount of gain or loss will Smithson recognize on retirement of the liability? (Enter your answer in whole dollars.)

Explanation / Answer

Details Cost Probability Expected cost Cash flow for restoration cost        650,000.00 50%                 325,000.00        750,000.00 15%                 112,500.00        600,000.00 35%                 210,000.00 Expected cash flow                 647,500.00 So expected cash flow for restoration cost at year 6= $    647,500.00 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 = $    483,849.67 Actual restoration cost incurred        696,000.00 Loss on liability estimate to be recognized .= $      48,500.00

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