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. In the year of acquisition, MMC incurred exploration and development costs of $60 million on the project.

MMC has a credit-adjusted risk free interest rate is 7%. It estimates the possible cash flows for restoring the land, three years after its extraction activities begin, as follows:

Cash Outflow				Probability
$	10	million			60	%
$	30	million			40	%

Additional info: PV of 1$ when n=3 & i=7 is 0.81630. FV of 1$ when n=3 & i=7 is 1.22504.

Required: What amount of accretion expense should be recorded at the end of the second year of extraction activities?

		$1,102,200
		$0
		$1,028,538
		$1,100,536

Answer 1

Ans:

Extraction Expense :

60% * 10M = $6M

40% * 30M = $12M

Expected extraction expense : $12M + $6M = $18M

PV of extraction Expense @7%

= $18M * 0.81630 = $14,693,400

All of these expense are to be booked in the first year itself.

In the second year of activity no expense should be booked for extraction activitites.

So correct answer is Option B. ($0)

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