Final answer:
The acquisition cost of an asset with a note payable below market interest rates is adjusted based on the present value of future cash flows, reflecting the difference in interest rates. Financial institutions in the secondary market value loans higher or lower based on current economic interest rates and the borrower's risk profile.
Step-by-step explanation:
When an asset is acquired and a note payable is assumed, the acquisition cost of the asset is determined taking into consideration the interest rate of the note as compared to the current market rate. If the note's interest rate is less than the current market rate, the present value of the future cash flows (payments on the note) will be lower than the face value of the note. Therefore, the acquisition cost of the asset will be adjusted to reflect the interest rate differential, which means the asset will be recorded at a discount to the face value of the note. Conversely, if the interest rate is higher than the market rate, the present value of the note would be greater, and the asset might be recorded at a premium.
In buying loans in the secondary market, financial institutions consider factors like the risk of non-repayment, the borrower's characteristics, and the current economic interest rates. An original loan with a low-interest rate is less valuable if current rates are high, while it's worth more if current rates are low. In the case of the Safe and Secure Bank, the interest rates and risk associated with their loans determined their secondary market value at $5 million.