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Intermediate Accounting (Kieso)
Found in: Page 311

Short Answer

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.

The NPV for 2016-2018 is $621,712.9977, for 2017-2019 is $271,292.9445 and it provides very useful information regarding the increase and decrease in the value of assets.

See the step by step solution

Step by Step Solution

Step 1: Calculation for part A

Year

2016-2018

Cash Inflows

375,000

Production cost

-125,000

Profit (cash flow)

250,000

Present Value of annuity factor (10% 3 years)

2.486851991

NPV

621712.9977

Step 2: Calculation for part B

Year

2017-2019

Cash Inflows

275,000

Production cost

-155,000

Profit (cash flow)

120,000

Present Value of annuity factor (10% 3 years)

2.260774537

NPV

271292.9445

Step 3: Calculation for Part C

The estimate of future cash flow is very useful as it provides the information and understanding of whether the value of gas and oil properties is increasing or decreasing from year to year. It also provides useful information for writing down the asset.

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