Question

# P10-3 Cayman Diving, Inc., needs to acquire a newdive boat. The seller will accept a noninterest-bearing...

P10-3 Cayman Diving, Inc., needs to acquire a newdive boat. The seller will accept a noninterest-bearing note for \$400,000 due in four years or \$250,000 in cash. The company’sincremental cost of borrowing is 10%.Required:Which option should Cayman Diving select? Would your answer change if Cayman’s incre-mental borrowingrate was 13%? Why?

Consider P10-3 Determining Asset Cost when purchasing with a note on page 586. Which option should Cayman Diving select? Would your answer change if Cayman’s incremental borrowing rate was 13%? Why?

#### Homework Answers

Answer #1

Solution:

Cash price of Boat = \$250,000

IF Boat is acquired through non interest bearing note then payable amount after 4 years = \$400,000

Incremental cost of borrowing = 10%

Present value of note = \$400,000 * PV factor at 10% for 4th period

= \$400,000 * 0.683013 = \$273,205

As cash price is lower than present value of note, therefore Caymon Diving should select cash purchase option.

If incremental borrowing rate was 13% then present value of note = \$400,000 * PV factor at 13% for 4th period

= \$400,000 * 0.613319 = \$245,328

If incremental borrowing rate is 13% then present value of note is lower than cash purchase price, therefore Boat should be purchased by issuing note.

Assets cost when purchasing with note = \$273,205

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