Water in the cylinders is one problem (engine, riser, ... ); water in the
bellows is another separate (maybe just a recent rip in the bellows) problem
(outdrive). So the mechanic will tear down the engine/outdrive, identify the
problems and the extent of the damage, and will replace/fix all for around
$5K cdn ... I'd say that's very reasonable.

$11K for a new 3.0L Mercruiser ... I'm thinking that would include the
Mercruiser (alpha) outdrive ($5K cdn here on a good day) as well? If it does
not include the outdrive, controls, etc I would definitely forget it. If it
does, well ... I'd say that's also very reasonable.

The important thing here imo is that you have stated that you know you are
dealing with a reputable shop ... so whichever way you go with this shop
(repair/rebuilt/upgrade), when all is said and done, your boat will be
operational for another 15 years :-).

Whereas, having your buddies or yourself fix it for $2K (including the
outdrive if it needs work other than the bellows, doing the alignment,
topping up all the fluids, etc, etc ) ... will the boat be operational for a
week, let alone for another 15 years :-) If it was me, I'd say $5K is very
reasonable.

The mechanic (from a reputable marine repair shop) found water in the
cylinders and bellows and, without knowing exactly what the problem is,
he says it is quite major (cracked block, head gasket, etc...). He
says he should probably push further (diagnose) only if I want to
commit to a rebuilt (as opposed to replacing the engine). They tell me
that whatever way I look at it, it should be at the minimum around
$5000 Cdn (approx. $4200 US).