(Fair Value Estimate) Murphy Mining Company recently purchased a quarts mine tha
ID: 2451555 • Letter: #
Question
(Fair Value Estimate) Murphy Mining Company recently purchased a quarts mine that 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 Chapter 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
Cash Outflow
Probability
Assessment
15,000
10%
22,000
30%
25,000
50%
30,000
10%
Instructions
What is the estimated fair value of Murphy’s asset retirement obligations? Murphy determines that the appropriate discount rate for this estimation is 5%. Round calculations to the nearest dollar.
Is the estimate developed for part (a) a Level 1 or Level 3 fair value estimate? Explain
Restoration Estimated
Cash Outflow
Probability
Assessment
15,000
10%
22,000
30%
25,000
50%
30,000
10%
Explanation / Answer
Calculation of probable cash outflows:
Estimated cash outflow Probability Probability * Cash flow
15,000 10% 1,500
22,000 30% 6,600
25,000 50% 12,500
30,000 10% 3,000
Expected cash outflow 23,600
Cash outflow in year 11, 12 and 13 23,600
Present value factor @ 5 % for 11,12,and 13 .5846, .5568, .5303
Present value of cash outflow: 23,600 * 1.6718 = 39,452
Estimated fairvalue of Asset's retirement obligation : 39,452
It is a Level 3 Estimate:
Level 1 estimate is possible when the assets have an active market. The assets have a market and a qouted price available company can use the market rate to determine fair value.
Here we have no such active market. Level 3 estimate is made when there is a little or no external market. It is based on company's on estimate and internal data.
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