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 $6.5 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) $590,000, 30% probability; (2) $640,000, 45% probability; and (3) $740,000, 25% probability. The company’s credit-adjusted, risk-free rate of interest is 5%.

What is the carrying value of the asset retirement liability at the end of one year?

Explanation / Answer

590000 * 30% = $177000

640000 * 45% = $288000

740000 * 25% = $185000

Restoration cost (177000+288000+185000)= $650000 * 0.783526165 (PV of $1, n=5,i=5%) = $509292

Carrying value of asset retirement liability at the end of one year = After one year the laibility will increase to ($509292+(509292*5%)) = $534756.6 i.e. $534757

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