The R. Morin Construction Company needs to borrow $100,000 to help finance the cost of a new $150,000 hydraulic crane used in the firm’s commercial construction business. The crane will pay for itself in one year, and the firm is considering the following alternatives for financing its purchase:
Alternative A. The firm’s bank has agreed to lend the $100,000 at a rate of 12 percent. Interest would be discounted, and a 16 percent compensating balance would be required. However, the compensating-balance requirement is not binding on the firm because it normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank.
Alternative B. The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan requires payment of principal and interest totaling $116,260.
a. Which alternative should Morin select?
b. If the bank’s compensating-balance requirement had necessitated idle demand deposits equal to 16
16 percent of the loan, what effect would this have had on the cost of the bank loan alternative?
a. The cost of Alternative A would be _____%. (Round to two decimal places.)
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