The R. Morin Construction Company

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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