Reference no: EM132089006

Question: Zero-Interest Note: To date, Prime Corp. has been able to finance its successful operations with investments from its principal owner and cash flows from operations. However, current expansion plans will require some borrowing to expand the company's production line. As part of the expansion plan, Prime will acquire some used equipment by signing a zero-interest-bearing note. The note has a maturity value of $60,000 and matures in 6 years. A reliable fair value measure for the equipment is not available, given the age and specialty nature of the equipment. As a result, Prime's accounting staff is unable to determine an established exchange price for recording the equipment (nor the interest rate to be used to record interest expense on the long-term note). They have asked you to conduct some accounting research on this topic.

(1) How is the present value of a zero-interest-bearing note determined when an established exchange price is not determinable and a note has no ready market? What is the resulting interest rate called?

(2) For Prime Corp., assume the market interest rate on the zero-interest-bearing note is determined to be 6%.

a) Using an Excel function, compute the fair value of the equipment.

b) Create a 6-year amortization schedule for this zero-interest-bearing note. Each cell in the schedule should be formula-based and not include any hard-input numbers.

(3) Now assume that the market interest rate is unknown.

a) What would the effective interest rate be if the fair value is determined to be $48,000 and the amortization period is 6 years? Use an Excel function to compute the rate.

b) Based on the fair value information in 3(a), create a new amortization schedule in Excel assuming that the amortization period is 8 years. Each cell in the schedule should be formula-based and not include any hard-input numbers.