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Chapter 6: 15P (page 311)

Murphy Mining Company recently purchased a quartz mine that it intends to work for the next 10 years. According to state environmental laws, Murphy must restore the mine site to its original natural prairie state after it ceases mining operations at the site. To properly account for the mine, Murphy must estimate the fair value of this asset retirement obligation. This amount will be recorded as a liability and added to the value of the mine on Murphy’s books. (You will learn more about these asset retirement obligations in Chapters 10 and 13.) There is no active market for retirement obligations such as these, but Murphy has developed the following cash flow estimates based on its prior experience in mining-site restoration. It will take 3 years to restore the mine site when mining operations cease in 10 years. Each estimated cash outflow reflects an annual payment at the end of each year of the 3-year restoration period.

Restoration Estimated Probability Cash Outflow Assessment $15,000 10% 22,000 30% 25,000 50% 30,000 10%

Instructions (a) What is the estimated fair value of Murphy’s asset retirement obligation? Murphy determines that the appropriate discount rate for this estimation is 5%. Round calculations to the nearest dollar. (b) Is the estimate developed for part (a) a Level 1 or Level 3 fair value estimate? Explain.

Short Answer

Expert verified

The present value is $20,681 and it is a level 3 fair value estimation.

Step by step solution

01

Calculation of present value

Restoration estimated cash outflows

Probability assessment

PV factor

Amount

A

B

C

A*B*C

15,000

10%

0.95238

1,429

22,000

30%

0.90703

5,986

25,000

50%

0.86384

10,798

30,000

10%

0.82270

2,468

Present value

20,681

02

Explanation for the level of the fair value of estimation

The estimation developed in part A is the level 3 fair value of estimation. As it is computed by using the complex model of present values.

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Most popular questions from this chapter

Using the appropriate interest table, compute the present values of the following periodic amounts due at the end of the designated periods. (a) \(30,000 receivable at the end of each period for 8 periods compounded at 12%. (b) \)30,000 payments to be made at the end of each period for 16 periods at 9%. (c) $30,000 payable at the end of the seventh, eighth, ninth, and tenth periods at 12%

Using the appropriate interest table, answer the following questions. (Each case is independent of the others). (a) What is the future value of 20 periodic payments of \(4,000 each made at the beginning of each period and compounded at 8%? (b) What is the present value of \)2,500 to be received at the beginning of each of 30 periods, discounted at 5% compound interest? (c) What is the future value of 15 deposits of \(2,000 each made at the beginning of each period and compounded at 10%? (Future value as of the end of the fifteenth period.) (d) What is the present value of six receipts of \)1,000 each received at the beginning of each period, discounted at 9% compounded interest?

Consolidated Natural Gas Company (CNG), with corporate headquarters in Pittsburgh, Pennsylvania, is one of the largest producers, transporters, distributors, and marketers of natural gas in North America.

Periodically, the company experiences a decrease in the value of its gas- and oil-producing properties, and a special charge to income was recorded in order to reduce the carrying value of those assets.

Assume the following information. In 2016, CNG estimated the cash inflows from its oil- and gas-producing properties to be \(375,000 per year. During 2017, the write-downs described above caused the estimate to be decreased to \)275,000 per year. Production costs (cash outflows) associated with all these properties were estimated to be \(125,000 per year in 2016, but this amount was revised to \)155,000 per year in 2017.

Instructions (Assume that all cash flows occur at the end of the year.)

(a) Calculate the present value of net cash flows for 2016–2018 (three years), using the 2016 estimates and a 10% discount factor.

(b) Calculate the present value of net cash flows for 2017–2019 (three years), using the 2017 estimates and a 10% discount factor.

(c) Compare the results using the two estimates. Is information on future cash flows from oil- and gas-producing properties useful, considering that the estimates must be revised each year? Explain.

Leon Tyler’s VISA balance is \(793.15. He may pay it off in 12 equal end-of-month payments of \)75 each. What interest rate is Leon paying?

Question:Identify three situations in which accounting measures are based on present values. Do these present value applications involve single sums or annuities, or both single sums and annuities? Explain.
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