Your company is commencing operations on a new open pit mine that is expected to operate for 9 years. Two possible approaches to reclamation are being considered, both of which involve some activities early in the life of the mine that do not interfere with the mine plan. One of the two approaches goes further, and involves 'progressive reclamation' that moves significant activities and costs earlier in the project schedule than the 'no progressive reclamation' approach

Work is being done to compare the timing, costs and present value of costs of the two approaches. Your supervisor says "We also need to assess the cash flows to and from our reclamation bond for each of these approaches, so they can be factored into our analysis"

The regulator has approved a reclamation bond structure under which the company must make deposits of cash to match step-ups in a profile of liability for estimated reclamation costs at various times in the mine's life. The reclamation bond would only be drawn upon in a situation in which the company failed to cover the costs of reclamation activities. Later in the mine's life, assuming the company stays on track with planned activities, the liability steps down and cash amounts are returned to the company. At the end of operations, a residual liability amount is retained in the bond structure for a number of years

You have the following information:

• in the 'no progressive reclamation' approach, required deposits are: $3 million today (time 0), $5 million in year 2, and $8 million in year 5, and returns to the company are: $4 million in year 8 and $7 million in year 9
• in the 'progressive reclamation' approach, required deposits are $3 million today (time 0), $5 million in year 2, and $2 million in year 6; and returns to the company are: $5 million in year 8
• the regulator requires a 2.5% discount rate to be used in any time value calculations related to the reclamation bond structure

You are asked to calculate the present value (PV) of net cash flows to/from the reclamation bond for each of the two approaches, as well as the equivalent annual value of these figures

Part 1 - (a) What kind of problem is this?

(b) Sketch a cash flow diagram for each of the two approaches, labelling all cash flow arrows and the time value factor(s) that you will need.

Part 2

(a)Calculate the present value (PV) of net cash flows to/from the bond, for each of the two approaches

(b)Calculate the equal annual amount (over the 9-year mine life) equivalent to the PV of net cash flows to/from the bond, for each of the two approaches

(c)A colleague who has been working on the estimated costs of the two approaches says "I have calculated the PV of differential costs of the 'progressive reclamation' approach relative to those of the 'no progressive reclamation' approach. Is there any differential figure from your work I should include to capture additional cash impacts on the company of the funding assurance structure?" Calculate a figure for your colleague, and briefly explain your calculation