Montana Mining Co. (MMC) paid 200 million for the right to explore and extract r

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%

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Present Value of Cash Flows Expected From the Project/Asset Retirement Obligation at the Beginning = (.60*10 + .40*30)*PVIF(7%,3 Years) = (.60*10 + .40*30)*.81630 = 14.7 million

Answer is 14.7 million.

Part B:

Asset Retirement Obligation One Year After = Present Value of Cash Flows Expected From the Project*(1+.07) = 14.7*(1+.07) = 15.7 million.

Answer is 15.7 million.

Thanks.

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