Question

For $20 million, Ross Adams Mining acquired a tract of land containing a large deposit of anthracite coal. Ross Adams believes the most economical way to extract the coal is to stripmine the site. The company is required by environmental regulations to restore the land after it has extracted the coal to a condition suitable for recreational use and—given the intended mining method—estimates restoration costs to be $6 million. Ross Adams’s mining engineers estimate that the site contains 4 million tons of recoverable coal and that it will take approximately four years to complete mining activities. Once restored, the estimated value of the land amounts to $1 million. Ross Adams Mining’s credit-adjusted risk free interest rate is 7%. Required: What should be the depletion rate per ton of coal extracted from this mine? (Do not round intermediate calculations. Round your final answer to 2 decimal places.

Answer 1

Answer:

$6.25 per ton of coal

Explanation:

the depletion base = purchase cost + restoration costs

• purchase cost = $20 million
• restoration costs = $6 million

depletion base = $26,000,000

depletion rate per ton of coal = (depletion base - salvage value) / estimated reserves = ($26,000,000 - $1,000,000) / 4,000,000 = $6.25 per ton of coal

The depletion rate follows the same concepts as depreciation of fixed assets, but instead of using a fixed asset, you are extracting materials and decreasing the value of the deposits.