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 1 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 14 percent. Interest would be discounted and a 15 percent compensating balance would be required. However, the compensating- balance requirement would not be binding on R. Morin be-cause the firm 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 would require payment of principal and interest totaling $ 116,300.
a. Which alternative should R. Morin select?
b. If the bank’s compensating- balance requirement were to necessitate idle demand deposits equal to 15 percent of the loan, what effect would this have on the cost of the bank loan alternative?