Bouygues Construction S.A., headquartered in Paris, France, needs to borrow €178,000 to help finance the cost of a new €200,000 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 A—The firm’s bank agrees to lend the €178,000 at a rate of 12 percent. Interest would be discounted, and a 13 percent compensating balance would be required. However, the compensating-balance requirement would not be binding on Bouygues Construction because the firm normally maintains a minimum demand deposit (checking account) balance of €28,000 in the bank.

Alternative B—The equipment dealer agrees to finance the equipment with a 1-year loan. The €178,000 loan would require payment of principal and interest totaling €185,500.

a. Which alternative should Bouygues Construction select?

b. If the bank’s compensating-balance requirement were to necessitate idle demand deposits equal to 13 percent of the loan, what effect would this have on the cost of the bank loan alternative?