Question

Newark Ltd is a manufacturing company that operates a production facility in the Sydney suburb of Blacktown. In January 2020 residents living adjacent to the production facility complained that the ground around their homes was being contaminated by waste discharged from Newark Ltd’s production facility. In May 2020, environmental officers from the City of Sydney Council confirmed that the ground was contaminated although they did not regard the contamination as posing a health risk. Although Newark Ltd is not legally required to restore the contaminated ground, Newark Ltd immediately responded by implementing new procedures for the storage and disposal of waste material to prevent any further contamination from occurring and then then made a series of public announcements that it would undertake to restore the contaminated ground in two years’ time.

As at 30 June 2020, Newark Ltd estimates the cost of restoring the contaminated ground as follows:

Cost Probability

$1,500,000 5% 900,000 5% 500,000 30% 350,000 60%

On 30 June 2020, the risk-free discount rate, based on two-year government bonds, is 6%. However, Newark Ltd believes that a discount rate of 4% is appropriate to adjust for the risks specific to this liability.

Answer 1

Since Probability of cost has been given at different cost, So we will identify the cost based on Probabilty and what may be the cost will be depicted as per below table

Probability (a)	Cost (b)	Expected cost (a*b)
5%	1,500,000	75,000
5%	900,000	45,000
30%	500,000	150,000
35%	350,000	122,500
		392,500

Since this cost will be for 2 year so to identify its present value we have to use the risk free factor given by govt bond i.e. 6% and hence its present value will be as below mentioned in Formula

Formula of Present Value (PV)
PV=	FV/(1+r)^n
Where PV is to be derived
FV (Future Value)=	$392,500
R is Interest Rate=	3%	2 year Govt Bonds, Since 6% is for 2 years and hence for 1 year it will be 3%
n is number of periods=	2 years

Hence PV= $392500/(1+0.03)^2

= $369,969