Next, let's model out the asset retirement obligation. In this oil and gas project, they drill a well, and at the end of the well's life there are shutdown costs. In our sources and uses tab, we are given assumptions about the termination costs of this project. And as you can see, those costs are toward the end of our timeline. In years 2029 and 2030, we're also provided with a discount rate. And this should be a pre-tax discount rate, which should be in line with the risk of the project. So a good idea is to estimate this discount rate using the average cost of debt of the project. So let's go back and model out our asset retirement obligation. But the first thing to know is that we are gonna assume that the asset retirement obligation is created at the end of the first year of construction when drilling starts.

So we're gonna compute the net present value of our termination costs using the NPV formula in Excel. For the rate, we're gonna use the 6% discount rate, and of course the termination costs will be the values, and that gives us a net present value of 37.2.

Now the amortization of the asset retirement obligation will be in line with our depletion. So what we need to do is take the net present value and divided by our total reserves, which we've calculated earlier of 89.4. Now we want this number to be negative since it's gonna be an expense.

And now we are ready to model out the asset retirement obligation asset.

Now, the accounting behind the asset retirement obligation creates an asset as well as a liability, but typically the asset is baked into the PP&E. Here we're showing the asset section as a separate section to illustrate how you would model it out. So let's begin by taking the 37.2 as our ending balance. At the end of the first year, we're gonna now build up our beginning balance and there is no amortization during the construction phase. So the ending balance is simply the sum of the 37.2 and the empty line for amortization.

We can copy this to the right into the first year of the operation of phase where we actually now need to add the amortization. Now to calculate the amortization, we can take our amortization per barrel of oil equivalent. We can lock that in and multiply times the total production for that year, which we've calculated up Here. And that is 4.5. Now we can take all three rows and copy them all the way to the last year of our operational phase. And as you can see, we have fully amortized our asset retirement obligation asset.