Question

Cost of​ short-term financing​) The R. Morin Construction Company needs to borrow ​$90 comma 000 to help finance the cost of a new ​$126 comma 000 hydraulic crane used in the​ firm's commercial construction business. The crane will pay for itself in 1​ year, and the firm is considering the following alternatives for financing its​ purchase:
Alternative Along dashThe ​firm's bank has agreed to lend the ​$90 comma 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 would not be binding on R. Morin because the firm normally maintains a minimum demand deposit​ (checking account) balance of $ 22 comma 500 in the bank.
Alternative Blong dash The equipment dealer has agreed to finance the equipment with a​ 1-year loan. The ​$90 comma 000 loan would require payment of principal and interest totaling ​$104 comma 544.
a. Which alternative should R. Morin​ select?
b. If the​ bank's compensating-balance requirement were to necessitate idle demand deposits equal to 16 percent of the​ loan, what effect would this have on the cost of the bank loan​ alternative?

Answer 1